Social Security Reform: Answers to Key Questions (02-MAY-05,	 
GAO-05-193SP).							 
                                                                 
The sooner our nation acts to address Social Security's long-term
financial challenges, the easier it will be to successfully meet 
them. Once explained, the choices we face are not difficult to	 
understand, but they are difficult to make. They affect both how 
much Americans pay for Social Security and how much they receive 
from the program. They require changes that not only will affect 
us but have implications for future generations. They also are	 
difficult because they involve deeply felt values, such as	 
community, individualism, fairness, and human dignity. This guide
tries to boil down the complexities of Social Security and the	 
implications of reform to the basic choices we face as a nation. 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-193SP					        
    ACCNO:   A24018						        
  TITLE:     Social Security Reform: Answers to Key Questions	      
     DATE:   05/02/2005 
  SUBJECT:   Federal social security programs			 
	     Financial management				 
	     Income maintenance programs			 
	     Program management 				 
	     Retirement income					 
	     Social security benefits				 
	     Strategic planning 				 
	     Cost analysis					 
	     Economic analysis					 
	     Trust funds					 
	     Retirement benefits				 
	     Beneficiaries					 
	     Social security taxes				 
	     Federal taxes					 
	     Benefit-cost tracking				 
	     Old Age Survivors and Disability			 
	     Insurance Program					 
                                                                 
	     Social Security Program				 
	     Social Security Trust Fund 			 

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GAO-05-193SP

     

     * Contents
     * Preface
          * Basically, how does Social Security work now?
               * 1. How did Social Security get started?
               * 2. What are Social Security's goals?
               * 3. How well has Social Security worked?
                    * Figure 1: Poverty Rates for Elderly Have Declined
                      Faster than for Other Groups
               * 4. What are the sources of income for the elderly?
                    * Figure 2: Elderly Households' Sources of Income, 2002
                    * Figure 3: Percentage of Elderly Households Receiving
                      Each Type of Income, 2002
               * 5. Who gets benefits?
               * 6. What benefits does Social Security offer?
                    * Figure 4: Benefit Formula Provides Higher Replacement
                      Rates for Lower Earners
               * 7. When can people get benefits?
                    * Table 1: Full Retirement Age is Increasing
               * 8. How much interest do workers' contributions earn?
               * 9. What is social insurance?
               * 10. Where do Social Security's revenues come from?
               * 11. How much is the Social Security payroll tax?
               * 12. Why is there a cap on taxable earnings?
               * 13. What interest rate do the Social Security trust funds
                 earn?
               * 14. Why are Social Security benefits taxed?
               * 15. What does "pay-as-you-go financing" mean?
               * 16. How do the Social Security trust funds relate to the
                 federal budget?
                    * Table 2: Fiscal Year 2004 Deficit Numbers
                    * Figure 5: Surplus or Deficit as a Share of GDP, Fiscal
                      Years 1980-2004
               * 17. Do Social Security taxes get spent on other government
                 programs?
               * 18. Aren't the Social Security trust funds like private
                 sector trust funds?
          * Why is there a need for Social Security Reform?
               * 1. What is the basic problem?
                    * Figure 6: Social Security's Costs Will Exceed its Cash
                      Revenues Beginning in 2017
               * 2. What are the root causes of this gap between costs and
                 revenues?
                    * Figure 7: The Aged Are Growing as a Share of the Total
                      Population
                    * Figure 8: Labor Force Growth Is Expected to be
                      Negligible by 2050
                    * Figure 9: Social Security Workers per Beneficiary
               * 3. When does the money run out?
                    * Figure 10: Social Security's Trust Fund Balance Grows
                      but then Declines Rapidly after 2027
               * 4. How big is the funding gap in dollars?
               * 5. Which horizon should we be looking at: 75 years or an
                 infinite horizon?
               * 6. Are there any issues other than solvency that call for
                 reform?
               * 7. When Social Security's benefit payments exceed its
                 income, where will the money come from?
               * 8. What is the outlook for the whole federal budget and its
                 capacity to pay benefits, especially when Medicare and
                 Medicaid are included?
                    * Figure 11: Federal Spending for Mandatory and
                      Discretionary Programs, Fiscal Years 1964, 1984, and
                      2004
                    * Figure 12: Composition of Spending as a Share of GDP,
                      Assuming Discretionary Spending Grows with GDP After
                      2004 and All Expiring Tax Provisions Are Extended
               * 9. What are the implications of this budgetary outlook for
                 the economy as a whole?
                    * Figure 13: Social Security, Medicare, and Medicaid
                      Spending as a Percentage of GDP
                    * Figure 14: Annual Personal Saving Rates, 1960 - 2004
               * 10. Why can't we wait for a more immediate solvency crisis
                 to reform Social Security?
                    * Figure 15: Size of Action Needed to Achieve Social
                      Security Solvency
               * 11. But what happens if we don't do anything?
               * 12. How should we evaluate the various options for Social
                 Security reform?
               * 13. Why do we hear claims about the effects of proposals
                 that directly contradict each other?
               * 14. What benchmarks should be used for comparison?
          * What are the options for Social Security reform?
               * 1. What are ways of changing the benefit formula?
                    * Figure 16: Social Security Benefit Formula Replaces
                      Earnings at Different Rates
               * 2. How could COLAs be reduced?
               * 3. How would increasing the retirement age work?
               * 4. What are the options for increasing tax revenues?
               * 5. Are there other ways to increase Social Security's
                 revenues?
               * 6. Who would manage the accounts?
               * 7. Would accounts be required for Social Security
                 participants?
               * 8. How much would go into the accounts?
               * 9. What's the difference between an add-on and a carve-out
                 account?
               * 10. What are transition costs?
               * 11. What investment options would there be?
               * 12. How would participants draw on the accounts for
                 retirement income?
               * 13. Would participants have any guarantee of doing better
                 than under the current system?
          * What are the implications of Social Security Reform?
               * 1. What will achieving sustainable solvency require?
               * 2. What effects do these options have on the overall federal
                 budget and the public debt?
               * 3. Can Social Security reforms promote economic growth and
                 worker productivity?
               * 4. How would benefit reductions affect the adequacy of
                 benefits?
               * 5. Does greater progressivity in benefits imply greater
                 income adequacy?
               * 6. What would happen to the adequacy of benefits for the
                 disabled, dependents, and survivors?
               * 7. How will individual equity be affected by these reform
                 options?
               * 8. What issues would arise in implementing these options?
               * 9. Would individual accounts help achieve solvency?
               * 10. What would it cost to create a system with individual
                 accounts?
               * 11. Aren't these transition costs less than the cost of
                 fixing the current system?
               * 12. What effect would individual accounts have on national
                 saving?
               * 13. How would individual accounts affect the adequacy of
                 benefits?
               * 14. What effect would individual accounts have on the
                 adequacy of benefits for the disabled, dependents, and
                 survivors?
               * 15. What issues would arise in implementing individual
                 accounts?
               * 16. What would happen to administrative costs with
                 individual accounts?
               * 17. What tools and educational efforts would workers need to
                 exercise the increased choices associated with individual
                 accounts?
          * Glossary of Key Terms
          * Related GAO Products

CONTENTS

PREFACE 1
BASICALLY, HOW DOES SOCIAL SECURITY WORK NOW? 3
How did Social Security get started? 3
What are Social Security's goals? 3
How well has Social Security worked? 3
: Poverty Rates for Elderly Have Declined Faster than for Other Groups 4
What are the sources of income for the elderly? 5
: Elderly Households' Sources of Income, 2002 6
: Percentage of Elderly Households Receiving Each Type of Income, 2002 6
Who gets benefits? 7
What benefits does Social Security offer? 7
: Benefit Formula Provides Higher Replacement Rates for Lower Earners 9
When can people get benefits? 9
: Full Retirement Age is Increasing 10
How much interest do workers' contributions earn? 10
What is social insurance? 12
Where do Social Security's revenues come from? 12
How much is the Social Security payroll tax? 13
Why is there a cap on taxable earnings? 13
What interest rate do the Social Security trust funds earn? 14
Why are Social Security benefits taxed? 14
What does "pay-as-you-go financing" mean? 15
How do the Social Security trust funds relate to the federal budget? 15
: Fiscal Year 2004 Deficit Numbers 16
: Surplus or Deficit as a Share of GDP, Fiscal Years 1980-2004 17
Do Social Security taxes get spent on other government programs? 17
Aren't the Social Security trust funds like private sector trust funds? 18
WHY IS THERE A NEED FOR SOCIAL SECURITY REFORM? 19
What is the basic problem? 19
: Social Security's Costs Will Exceed its Cash Revenues Beginning in 2017
19
What are the root causes of this gap between costs and revenues? 20
: The Aged Are Growing as a Share of the Total Population 20
: Labor Force Growth Is Expected to be Negligible by 2050 21
: Social Security Workers per Beneficiary 22
When does the money run out? 22
: Social Security's Trust Fund Balance Grows but then Declines Rapidly
after 2027 23
How big is the funding gap in dollars? 23
Which horizon should we be looking at: 75 years or an infinite horizon? 24
Are there any issues other than solvency that call for reform? 25
When Social Security's benefit payments exceed its income, where will the
money come from? 26
What is the outlook for the whole federal budget and its capacity to pay
benefits, especially when Medicare and Medicaid are included? 27
: Federal Spending for Mandatory and Discretionary Programs, Fiscal Years
1964, 1984, and 2004 28
: Composition of Spending as a Share of GDP, Assuming Discretionary
Spending Grows with GDP After 2004 and All Expiring Tax Provisions Are
Extended 29
What are the implications of this budgetary outlook for the economy as a
whole? 29
: Social Security, Medicare, and Medicaid Spending as a Percentage of GDP
30
: Annual Personal Saving Rates, 1960 - 2004 31
Why can't we wait for a more immediate solvency crisis to reform Social
Security? 31
: Size of Action Needed to Achieve Social Security Solvency 33
But what happens if we don't do anything? 33
How should we evaluate the various options for Social Security reform? 34
Why do we hear claims about the effects of proposals that directly
contradict each other? 35
What benchmarks should be used for comparison? 35
WHAT ARE THE OPTIONS FOR SOCIAL SECURITY REFORM? 37
What are ways of changing the benefit formula? 37
: Social Security Benefit Formula Replaces Earnings at Different Rates 38
How could COLAs be reduced? 40
How would increasing the retirement age work? 41
What are the options for increasing tax revenues? 41
Are there other ways to increase Social Security's revenues? 42
Who would manage the accounts? 44
Would accounts be required for Social Security participants? 44
How much would go into the accounts? 44
What's the difference between an add-on and a carve-out account? 45
What are transition costs? 45
What investment options would there be? 46
How would participants draw on the accounts for retirement income? 46
Would participants have any guarantee of doing better than under the
current system? 47
WHAT ARE THE IMPLICATIONS OF SOCIAL SECURITY REFORM? 48
What will achieving sustainable solvency require? 48
What effects do these options have on the overall federal budget and the
public debt? 48
Can Social Security reforms promote economic growth and worker
productivity? 49
How would benefit reductions affect the adequacy of benefits? 49
Does greater progressivity in benefits imply greater income adequacy? 50
What would happen to the adequacy of benefits for the disabled,
dependents, and survivors? 51
How will individual equity be affected by these reform options? 51
What issues would arise in implementing these options? 52
Would individual accounts help achieve solvency? 52
What would it cost to create a system with individual accounts? 53
Aren't these transition costs less than the cost of fixing the current
system? 53
What effect would individual accounts have on national saving? 54
How would individual accounts affect the adequacy of benefits? 54
 1. What effect would individual accounts have on the adequacy of benefits
       for the disabled, dependents, and survivors?
 2. What issues would arise in implementing individual accounts? 55
 3. What would happen to administrative costs with individual

      accounts?                                                         56 
      17. What tools and educational efforts would workers need to  
      exercise the increased choices associated with individual     
      accounts?                                                         56 
      V. GLOSSARY OF KEY TERMS                                          58 
      VI. RELATED GAO PRODUCTS                                          68 

                                     ERRATA

On May 18, 2005, this document was revised as follows: text was revised on
pages 7, 21, and 42; numerical changes were made in table 2 on page 16;
and revisions were made to figure 1 on page 4, figure 4 on page 9, figure
5 on page 17, and figure 11 on page 28. In addition, revisions were made
to figure 12 on page 29 and figure 13 on page 30 to correct color-related
problems that occurred only in the printed version.

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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separately.

financial challenges, the easier it will be to successfully meet them.

Once explained, the choices we face are not difficult to understand, but
they are difficult to make. They affect both how much Americans pay for
Social Security and how much they receive from the program. They require
changes that not only will affect us but have implications for future
generations. They also are difficult because they involve deeply felt
values, such as community, individualism, fairness, and human dignity.
This guide tries to boil down the complexities of Social Security and the
implications of reform to the basic choices we face as a nation.

Social Security eventually provides benefits to tens of millions of
Americans: workers and the families of workers who become disabled or die,
as well as to those who retire. Those benefits are designed to replace
some of the earnings that such workers lose, but not all of them. Social
Security was never intended to guarantee an adequate income. Also, they
are available only to workers, and their families, who have contributed to
the system.

People are living longer than ever before, and they are expected to live
even longer in the future. If workers keep retiring at the same age as
they do now, they will collect retirement benefits for more years than
past workers did. If the level of those benefits relative to wages stays
the same, then lifetime benefits would cost more simply because those
lifetimes are longer. So this longer life expectancy presents workers with
a basic choice: How much of their earnings should they spend during their
peak employment years, and how much should they save for retirement? Yet,
workers also have other options. They can choose to work longer and have
more total earnings to spread over their lifetimes; they can also choose
to invest their savings in ways that earn higher returns, but to do so
they have to take more risk.

With or without Social Security, workers face these basic choices as they
plan for longer lives. The choices we collectively face for Social
Security are very similar for the very same reasons. And with Social
Security, the choices will affect not only the program and its
beneficiaries but also the federal budget and the national economy.

This guide provides answers to questions about the most basic aspects of
Social Security and reform issues in a concise and easy-to-understand
format. We provide straightforward answers to how Social Security works,
why it needs reform, what the basic options are, and how to assess their
implications. For readers interested in a deeper and more detailed
discussion, we include a bibliography of related GAO products. A glossary
defining key terms is included at the back of this document.

This report was prepared under the direction of Barbara D. Bovbjerg,
Director, Education, Workforce, and Income Security Issues, who may be
reached at (202) 512-7215. Charlie Jeszeck, Michael Collins, Ken
Stockbridge, and Derald Seid made key contributions to this publication.

David M. Walker Comptroller General of the United StatesU.S. Government
Accountability Office

Basically, how does Social Security work now?

  I. SOCIAL SECURITY'S GOALS

1. How did Social Security get started?

When Social Security was enacted, in 1935, the nation was in the midst of
the Great Depression. About half of the elderly (people age 65 and over)
depended on others for their livelihood, and roughly one-sixth received
public charity. Many had lost their savings. Social Security was created
to help ensure that the future elderly would have adequate retirement
incomes and would not have to depend on welfare. It would provide benefits
that workers had earned because of their own contributions and those of
their employers. In 1939, coverage was extended to dependents and
survivors. The Disability Insurance (DI) program was added in 1956.
Officially, Social Security is now called the Old-Age, Survivors, and
Disability Insurance (OASDI) program.

2. What are Social Security's goals?

Helping ensure adequate retirement income is a fundamental goal of Social
Security.1 While Social Security was never intended to guarantee an
adequate income by itself, it provides an income base upon which to build.
At the same time, Social Security is intended to reduce dependency on
welfare, so the system is funded by workers' contributions that establish
their eligibility to receive benefits. Both contributions and benefits are
based on earnings. Accordingly, another goal of the program is to ensure
that benefits bear some relationship to contributions. This goal is known
as individual equity.2 The Social Security program, in effect, balances
the goal of income adequacy and individual equity. The benefit formula
seeks to ensure adequacy by providing somewhat higher benefits, relative
to wages, for lower-income workers than higher-income workers. At the same
time, the formula also promotes some degree of individual equity by
ensuring that benefits are somewhat higher for workers with higher
lifetime earnings.

3. How well has Social Security worked?

In 2004, Social Security paid almost $493 billion in benefits to more

1

GAO, Social Security: Program's Role in Helping Ensure Income Adequacy,
GAO-02-62 (Washington, D.C.: Nov. 30, 2001).

2

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

than 47 million people. This currently represents 22 percent of the
federal budget and 4.3 percent of our nation's gross domestic product
(GDP).3Social Security has contributed to reducing poverty among the
elderly. (See fig. 1.) Since 1959, poverty rates for the elderly have
dropped by more than two-thirds, from 35 percent to about 10 percent in
2003. While poverty rates for the elderly in 1959 were higher than for
children or for working-age adults (aged 18 to 64), in 2003 they were
lower than for either group. Factors other than Social Security, for
example, employer-provided pensions have also contributed to lower poverty
for the elderly. Still, for about half of today's elderly, their incomes
net of Social Security benefits are below the poverty threshold, the level
of income needed to maintain a minimal standard of living. Nearly
two-thirds of the elderly get at least half of their income from Social
Security. One in five elderly Americans has no income other than Social
Security.

Figure 1: Poverty Rates for Elderly Have Declined Faster than forOther
Groups

Moreover, poverty is higher for some subgroups of the elderly than for the
elderly as a whole. Women, members of minorities, and persons aged 75 and
older are much more likely to be poor than other elderly persons. For
example, compared with 10 percent for all elderly persons (aged 65 and
older) in 2003, poverty rates were 21 percent for all elderly women living
alone, roughly 22 percent for elderly blacks and Hispanics, and about 32
percent for black women 75 and older. Unmarried women make up more than 70
percent of poor elderly households, although they account for only 45
percent of all elderly households.

At about 19 percent, poverty rates in 2000 were much higher for disabled
workers age 16-64 than for the elderly (13.2 percent). Like the rates for
the elderly, poverty rates for disabled workers are higher for women,
minorities, unmarried persons, and those living alone. Social Security
provides an important source of income for the disabled. In 1999, disabled
workers made up 11 percent of all OASDI beneficiaries. As with the
elderly, Social Security is a major component (38 percent) of family
income for disabled worker families. Also, 48 percent of disabled worker
families get half of their income or more from Social Security, as of
1999, while 6 percent have no other income.

4. What are the sources of income for the elderly?

The four major sources of income for the elderly are Social Security,
employer pensions, income from saved assets, and earnings. While Social
Security provides income to 90 percent of elderly households, it provides
just 39 percent of their total retirement income. (See figs. 2 and 3.)
Pensions, savings, and earnings provide income to considerably fewer
households but together provide 58 percent of elderly households' total
income. They largely determine which households have the highest
retirement incomes. Less than 3 percent comes from other sources, and less
than 1 percent comes from public assistance. Medical benefits, including
Medicare and Medicaid, also help relieve a major cost burden on the
elderly, especially as health care costs grow much faster than inflation.

GDP is the value of all goods and services produced within the United
States in a given year and is conceptually equivalent to incomes earned in
production.

             Figure 2: Elderly Households' Sources of Income, 2002

Figure 3: Percentage of Elderly Households Receiving Each Type of Income,
2002

  SOCIAL SECURITY'S BENEFITS

5. Who gets benefits?

Social Security benefits are paid to workers who meet requirements for the
time they have worked in "covered employment," that is, jobs through which
they have paid Social Security taxes. Social Security covers about 96
percent of all U.S. workers; the vast majority of the rest are state,
local, and federal government employees.4 Typically, workers must
contribute for a total of 40 quarters (or ten years in total) to qualify,
though the requirements are different if they become disabled or die.
Workers and their dependents generally become eligible to collect benefits
when the workers reach age 62, become disabled, or die.

Benefits are paid to family members of workers under certain
circumstances. Spouses and divorced spouses of eligible workers may also
be eligible at age 62 but can be eligible at younger ages if they are
disabled, widowed, or caring for eligible children. An eligible worker's
children under 18 are also eligible, and adult children are eligible if
they became disabled before age 22. Dependent parents and grandchildren of
eligible workers are also eligible for survivors benefits under certain
circumstances.

Some workers qualify for Social Security benefits from both their own work
and their spouses'. Such workers are called dually entitled spouses. Such
workers do not receive both the benefits earned as a worker and the full
spousal benefit; rather the worker receives the higher amount of the two.

6. What benefits does Social Security offer?

Social Security benefits are designed to partially replace earnings that
workers lose when they retire, become disabled, or die. As a result, the
first step of the benefit formula calculates a worker's average, indexed
monthly earnings (AIME), which is based on the highest 35 years' earnings
on which they paid Social Security taxes. The formula adjusts these
lifetime earnings, or indexes them to changes in average wages, to account
for the fact that

About one-fourth of public employees do not pay Social Security taxes on
the earnings from theirgovernment jobs. Historically, Social Security did
not require coverage of government employees because there was concern
over the question of the federal government's right to impose a tax on
state governments and some had their own retirement systems. In 1983,
Congress extendedmandatory coverage to newly hired federal workers and to
all members of Congress, regardless ofwhen they entered Congress. See GAO,
Social Security: Issues Relating to Noncoverage of PublicEmployees,
GAO-03-710T (Washington, D.C.: May 1, 2003).

earnings across all workers grow over time.

Then, the benefit formula replaces a percentage of those pre-retirement
earnings, replacing a larger share of earnings for lower earners than for
higher earners. For example, retired workers receive benefits that equal
about 50 percent of pre-retirement earnings for a worker with relatively
lower earnings (45 percent of the average wage) but only about 30 percent
of earnings for one with relatively higher earnings (160 percent of the
average wage). To help ensure that beneficiaries have adequate incomes,
Social Security's benefit formula is designed to be progressive, that is,
to provide disproportionately larger benefits, as a percentage of
earnings, to lower earners than to higher earners.5

GAO, Social Security: Distribution of Benefits and Taxes Relative to
Earnings Level, GAO-04-747 (Washington, D.C.: June 15, 2004).

Figure 4: Benefit Formula Provides Higher Replacement Rates forLower
Earners

Note: Replacement rates are the annual retired worker benefits at age 65
for workers born in 1985 divided by the earnings in the previous year. For
such workers, the full retirement age will be 67. Steady earners have
earnings equal to a constant percentage of Social Security's Average Wage
Index in every year of their careers. Those percentages are 45, 100, and
160, respectively, for low, average, and high earners. Benefits for
disabled workers use the same formula, but since workers become disabled
at different ages, it is more difficult to calculate a consistent
replacement rate. See GAO, Social Security: Distribution of Benefits and
Taxes Relative to Earnings Level, GAO-04-747 (Washington, D.C.: June 15,
2004) for more on replacement rates.

Finally, the benefit formula makes other adjustments to reflect various
other provisions, such as those relating to early or delayed retirement,
type of beneficiary, and maximum family benefit amounts. In addition, once
payments have begun, Social Security benefits are adjusted annually to
reflect inflation.

7. When can people get benefits?

For retired workers and their dependents, Social Security pays full
benefits at the full retirement age, also known as the normal retirement
age (NRA), which historically has been age 65. However, under current law,
the full retirement age is gradually increasing, beginning with retirees
born in 1938, and will reach 67 for those born in 1960 or later. (See
table 1.) People may choose to retire at age 62 and receive reduced
benefits.6 The reduction for early retirement takes account of the longer
period of time over which benefits will be paid.

Table 1: Full Retirement Age is Increasing

Year of Birth                         Full Retirement Age                  
1937 or earlier                       65                                   
1938                                  65 and 2 months                      
1939                                  65 and 4 months                      
1940                                  65 and 6 months                      
1941                                  65 and 8 months                      
1942                                  65 and 10 months                     
1943-1954                             66                                   
1955                                  66 and 2 months                      
1956                                  66 and 4 months                      
1957                                  66 and 6 months                      
1958                                  66 and 8 months                      
1959                                  66 and 10 months                     
1960 and later                        67                                   

Source: SSA.

For disabled workers and their dependents, Social Security pays benefits
for workers who are unable to work in any job and whose disabilities are
expected to last for at least 1 year or to result in death. Social
Security does not pay benefits for short-term or partial disability. Also,
benefits do not begin until a worker has been disabled for 5 full
consecutive months.

For survivors of deceased workers, Social Security pays benefits upon the
death of the worker for those who satisfy the relevant age requirements.
For example, a widow can start receiving benefits as early as age 60 or,
if she is disabled, age 50.

8. How much interest do workers' contributions earn?

Workers do not earn interest on their Social Security contributions as
they would on a savings account. Their contributions are not deposited in
interest-bearing accounts for individual workers. Rather, their
contributions

Social Security also pays reduced benefits as early as age 62 for spouses,
and widow(er)s.

are credited to the Social Security trust funds, which are primarily used
to pay current benefits. Any contributions not used for current benefits
are invested in interest-bearing federal government securities that are
not readily marketable but backed by the full faith and credit of the U.S.
government. The benefit payments paid to any given individual are derived
from a formula that does not use interest rates or the amount of
contributions but rather uses the individual's average indexed lifetime
earnings as a basis for determining benefits.

In technical terms, Social Security provides a defined-benefit pension,
not a defined-contribution pension. A defined-benefit pension generally
provides a periodic benefit based on a specific formula generally linked
to each worker's earnings and years of employment. In contrast, a
defined-contribution pension resembles an individual savings or investment
account; retirement income from this type of pension depends on the total
amount of contributions to the account and any investment earnings. As an
example, 401(k) accounts are a type of defined-contribution pension.

The benefits workers receive under Social Security do, however, reflect a
rate of return that they implicitly receive on their contributions.7 This
implicit rate equals the interest rate that workers would hypothetically
have to earn on their contributions to pay exactly for all the benefits
they and their families will receive over the course of their lives. This
implicit rate of return provides one measure of individual equity, that
is, the relationship between contributions and benefits. It is important
to recognize that this implicit rate of return individuals receive on
their contributions is not the same as the interest that the Social
Security trust funds earn on their assets. Implicit rates of return for
individuals depend on the relationship between lifetime benefits and
contributions, while the interest earned by the trust funds reflects the
prevailing rates of interest in the market.

Implicit rates of return that individual workers receive on their Social
Security contributions vary significantly across a number of dimensions.
The variations mostly reflect several types of income transfers that the
program is designed to provide as part of its social insurance function.
Implicit returns vary by birth year, reflecting the program's income
transfers to the first generations of retirees from subsequent
generations.8 For example,

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

the inflation-adjusted (or "real") implicit rate of return averaged more
than 25 percent annually for the earliest retirees covered by Social
Security. For the baby boomers (those people born between 1946 and 1964),
the real implicit rate of return is projected to be around 2 percent,
according to a Social Security Administration (SSA) study.9 Implicit
returns that workers receive also vary on average by their earnings level,
by the number of their dependents and survivors, by their life
expectancies, and whether they become disabled. These characteristics vary
by race and gender and therefore the associated implicit rates of return
do also.

9. What is social insurance?

Under a social insurance program, society as a whole insures its members
against various risks they all face, and members pay for that insurance
through contributions to the system. Social Security is a social insurance
program through which the government assumes some of the responsibility
for a variety of risks that workers face regarding their retirement income
security. Such risks include individually based risks, such as how long
they will be able to work, how long they will live, whether they will be
survived by a spouse or other dependents, how much they will earn and save
over their lifetimes, and how much they will earn on retirement savings.
Workers also face some collective risks, such as the performance of the
economy and the extent of inflation. Different types of retirement income
embody different ways of assigning responsibility for these risks. For
example, employers sponsoring defined benefit pension plans bear the risk
of investing a plan's assets and ensuring that contributions are adequate
to fund promised benefits. In contrast, individuals saving for retirement
bear that investment risk.

  SOCIAL SECURITY'S REVENUES

10. Where do Social Security's revenues come from?

Social Security's revenues generally come from three sources:
contributions in the form of payroll taxes, interest on the trust funds,
and

8

While these early beneficiaries may have received a substantial income
transfer within the Social Security system, as a group they contributed
substantial amounts outside the system to theretirement incomes of their
parents' generation, which did not qualify for Social Security benefits.
Such contributions included not only income support that some provided to
their own parents butalso taxes and charitable contributions that paid for
other forms of support.

9

Dean R. Leimer, Cohort-Specific Measures of Lifetime Net Social Security
Transfers, working paper 59 (Washington, D.C.: SSA, Office of Research and
Statistics, Feb. 1994)

income taxes attributable to Social Security benefits. In 2004, the shares
of total revenue were

     o 84.1 percent from payroll taxes,
     o 13.5 percent from interest on the trust funds, and
     o 2.4 percent from income taxes on Social Security benefits.

11. How much is the Social Security payroll tax?

In 2005, workers pay a payroll tax of 6.2 percent of their covered wage
earnings up to $90,000 into Social Security, that is, into the OASDI trust
funds. Their employers pay an equal amount for a combined total tax rate
of 12.4 percent. Most analysts agree that employees ultimately pay the
employers' share because employers pay lower wages than they would if the
employers' contribution did not exist. Self-employed workers pay

12.4 percent, but they are allowed an income tax deduction for half of the
payroll tax. This deduction parallels the favorable tax treatment that
employers receive on their share of the payroll tax. Of the 12.4 percent
tax, 1.8 percent is allocated specifically to Disability Insurance. The
other

10.6 percent is allocated to Old-Age and Survivors Insurance. In addition,
workers and their employers each pay a payroll tax of 1.45 percent of all
wage earnings (without any cap) into Medicare.

When Social Security started collecting payroll taxes in 1937, the total
payroll tax rate was 2 percent. Higher rates were not necessary because
only a small share of the elderly had contributed enough to the program to
qualify for benefits. As the system matured-that is, as each year passed
and another group of people reaching retirement age qualified for
benefits- benefit costs increased and tax rates eventually were increased
accordingly. When the program began, payroll taxes were anticipated to
increase over time with the growth in benefit payments as the system
matured and more retirees received benefits.

12. Why is there a cap on taxable earnings?

The cap on taxable earnings in 2005 is $90,000. This cap is technically
known as the contribution and benefit base because the same cap also
effectively limits the earnings that can be used in the benefit formula.
This in turn limits the size of benefits, reflecting the program's role of
only providing for a floor of protection. Limiting the size of benefits
also limits the program's costs and the payroll taxes needed to pay for
them.

The cap on taxable earnings has also changed over time. The maximum annual
earnings subject to the payroll tax were only $3,000 in 1937. However, in
1937, 97 percent of all covered workers had total earnings below $3,000.
In recent years, about 94 percent have had total earnings below the
taxable maximum.

13. What interest rate do the Social Security trust funds earn?

In 2004, the Social Security trust funds earned interest at an effective
nominal annual rate of 5.7 percent (or 3.1 percent after inflation). By
law, the Social Security trust fund invests in securities backed by the
federal government and receives a relatively low return that reflects the
low level of relative risk. The interest rate on special Treasury
securities is equal, at the time of issue, to the average market yield on
outstanding marketable government securities not due or redeemable for at
least 4 years. This statutory rate was intended to confer neither an
advantage nor a disadvantage on the trust fund but was intended to
approximate how much it would cost the government to borrow from the
public for the long term.

14. Why are Social Security benefits taxed?

Since 1984, some Social Security beneficiaries have had to pay federal
income tax on up to one-half of their Social Security benefits.10 These
income tax revenues are returned to the Social Security trust funds. In
2004, they provided 2 percent of the trust funds' total income.11
Currently, about two-thirds of Social Security beneficiaries are not
affected by the taxation of benefits. This tax treatment of Social
Security benefits roughly parallels the tax treatment of similar
defined-benefit pension benefits.12

In addition, because of changes in 1993, some of these beneficiaries also
have to pay federal income taxes on an additional 35 percent of their
benefits. However, the additional revenues collected from this source are

10

Individual income tax filers pay this tax if their adjusted gross income
plus tax-exempt interest income plus one-half their Social Security
benefits exceeds $25,000. A married couple filing jointly will pay the tax
if this income exceeds $32,000. These levels are not adjusted for
inflation, so the percentage of beneficiaries paying tax on Social
security benefits is expected to rise in the future.

11

The Social Security trust funds also receive interest income that is not
subject to tax. In 2004,14 percent of the trust funds' income came from
interest on the Social Security trust funds.

12

In most defined-contribution pensions, such as 401(k) plans, contributions
are made from tax-deferred income and participants are subject to income
taxation on all benefits they receive.

dedicated to the Hospital Insurance (HI, or Medicare Part A) trust fund
and do not increase OASDI revenues.

15. What does "pay-as-you-go financing" mean?

Social Security is financed largely on a pay-as-you-go basis. In a
pay-as-you-go system, contributions that workers make in a given year are
used primarily to pay beneficiaries in that same year. Social Security is
now temporarily deviating from pure pay-as-you-go financing by building up
reserves that are by law invested in Treasury bonds. This situation has
arisen partly because the baby boom generation makes the size of the
workforce larger relative to the beneficiary population. In contrast, in a
fully funded, or advance funded, system, contributions for a given year
are put aside to pay for future benefits. The investment earnings on these
funds contribute considerable revenues and reduce the size of
contributions that would otherwise be required to pay for the benefits.
Defined-contribution pensions and individual retirement accounts (IRAs)
are fully funded by definition, as the benefits received equal the funds
accumulated in the account. Also, defined-benefit employer pensions are
designed with the goal of being advance funded: however, at any given
point in time total assets may be more or less than accrued liabilities
and obligations. The pension funds accumulate substantial assets that
constitute a large share of national saving.

Virtually from the beginning, Social Security was financed on a
pay-as-you-go basis. Congress had rejected the idea of advance funding for
the program. Many expressed concern that if the federal government amassed
huge reserve funds, it would find a way to spend them. Social Security has
run a surplus (e.g. $151 billion in fiscal 2004). Also, if the trust funds
were invested in private securities, some people would be concerned about
the influence that government could have on the private sector (e.g.
social investing).

                     SOCIAL SECURITY AND THE FEDERAL BUDGET

16. How do the Social Security trust funds relate to the federal budget?

The Social Security trust funds are sub-accounts within the federal
accounting and budget systems. Trust funds are budget accounts that are
used to record receipts and expenditures earmarked for specific purposes
and designated as trust funds by law.13 The Department of the Treasury has
permanent authority to make Social Security benefit payments when there is
a fund balance sufficient to make those payments. As a result, benefit
payments do not require annual appropriations from Congress. The trust
funds also provide a contingency reserve to help ensure that short-term
economic downturns do not result in funding shortfalls.

The Social Security trust funds are not included in the measure of the
federal budget that is known as the "on-budget" deficit. However, the
trust fund's "off-budget" status does not change the way its year-to-year
finances contribute to the government's impact on the economy. Therefore,
Social Security is included, along with all other federal programs, in the
commonly used unified budget measure. The unified budget measures the
government's current incremental borrowing from the public and related
draw on financial markets. Social Security's current cash surplus, plus
interest earned on treasury securities held by the trust funds, partially
offsets the deficit in the rest of the government's accounts. (See table 2
and fig. 5.)

Table 2: Fiscal Year 2004 Deficit Numbers

                                 Billions of dollars        Percentage of GDP 
On-budget deficit                           (567)                    (4.9) 
Off-budget surplus                           155*                      1.3 
Unified deficit                             (412)                    (3.6) 

Source: OMB. aThis includes the $151 billion Social Security surplus and a
$4 billion surplus for the Postal Service.

GAO, Federal Trust and Other Earmarked Funds: Answers to Frequently Asked
Questions, GAO-01-199SP (Washington, D.C.: Jan. 2001).

Figure 5: Surplus or Deficit as a Share of GDP, Fiscal Years 19802004

17. Do Social Security taxes get spent on other government programs?

Yes. By law, the Social Security trust funds must invest in
interest-bearing federal government securities.14 Treasury then uses the
cash to pay for other government expenses. In effect, Treasury uses Social
Security's excess revenues to help reduce the amount it must borrow from
the public to finance other federal programs. In other words, Social
Security's excess revenues help reduce the overall, or unified, federal
budget deficit. If Treasury could not borrow from the trust funds, it
would have to borrow more in the private capital market and pay such
interest in cash to finance current budget policy. However, Treasury still
has to pay the trust funds interest on these securities. When Social
Security needs to draw on the trust

These securities, while unmarketable, are backed by the full faith and
credit of the U.S.government and guaranteed as to both principal and
interest.

funds to pay benefits, Treasury provides cash in exchange for redeemed
trust fund securities.15

18. Aren't the Social Security trust funds like private sector trust
funds?

No. Most federal trust funds, including the Social Security trust funds,
do not have the fiduciary relationships that characterize private trust
funds. Unlike private trust funds, which are managed largely on behalf of
the beneficiary, the federal government has much more flexibility and
latitude. The Office of Management and Budget (OMB) summarizes the
differences between federal and private trust funds as follows:

"The beneficiary of a private trust owns the trust's income and often its
assets. A custodian manages the assets on behalf of the beneficiary
according to the stipulations of the trust, which he cannot change
unilaterally. In contrast, the Federal Government owns the assets and
earnings of most Federal trust funds, and it can unilaterally raise or
lower future trust fund collections and payments, or change the purpose
for which the collections are used, by changing existing law." 16

15

For more detail about the temporary trust fund buildup and how it
interacts with the federalbudget, see GAO, Social Security Financing:
Implications of Government Stock Investing for theTrust Fund, the Federal
Budget, and the Economy, GAO/AIMD/HEHS-98-74 (Washington, D.C.: Apr. 22,
1998), and GAO, Social Security Reform: Demographic Trends Underlie
Long-Term Financing Shortage, GAO/T-HEHS-98-43 (Washington, D.C.: Nov. 20,
1997).

16

OMB, Analytical Perspectives, Chapter 17, "Trust Funds and Federal Funds"
(Washington, D.C.: Government Printing Office, February 1998), p. 321.

Why is there a need for Social Security Reform?

  SOCIAL SECURITY'S OUTLOOK

II.

1. What is the basic problem?

Social Security's benefit costs will soon start to grow rapidly. In 2017,
Social Security is projected to pay out more cash in benefits than it
receives in revenues.1 As figure 6 shows, after that time, the gap between
costs and income grows continuously, and, unless action is taken to close
this gap, the trust funds will eventually be depleted in 2041.

Figure 6: Social Security's Costs Will Exceed its Cash Revenues Beginning
in 2017

This and all subsequent estimates are from the 2005 Trustees' Report and
reflect the intermediate assumptions. Because the future is uncertain, the
trustees use three alternative sets of assumptionsto show a range of
possible outcomes. The intermediate assumptions represent the Social
Security Administration's best estimate of the trust funds' future
financial outlook. The trustees also present estimates using low cost and
high cost sets of assumptions.

2. What are the root causes of this gap between costs and revenues?

Life expectancy has increased continually since the 1930s, and further
improvements are expected. As a result of this, along with the aging of
the baby boom generation, the aged population is growing dramatically.
(See fig. 7.) Today, those aged 65 and over are 12 percent of the
population. In 30 years, they will be more than 20 percent of the
population.

Figure 7: The Aged Are Growing as a Share of the Total Population

Note: Projections based on the intermediate assumptions of the 2005
Trustees' Report.

At the same time, the growth of the labor force is expected to slow
dramatically. Fertility rates are falling. The fertility rate is the
average number of children born to women during their childbearing years.
In the 1960s, the rate was an average of 3 children per woman. Today it is
a little over 2 and is expected to fall somewhat further and remain lower
than what it takes to maintain a stable population. In addition, the
relatively rapid growth of participation in the labor force by older women
is expected to slow. Baby boomers will also be leaving the labor force as
they retire. By 2025, labor force growth is expected to be less than a
third of what it is today. (See fig. 8.)

       Figure 8: Labor Force Growth Is Expected to be Negligible by 2050

Note: This analysis is based on the intermediate assumptions of the 2005
Social Security trustees' report. The percentage change is calculated as a
centered 5-year moving average.

As a result of the aging population and the slower labor force growth,
fewer workers will be contributing to Social Security for each aged,
disabled, dependent, or surviving beneficiary. While 3.3 workers support
each Social Security beneficiary today, only 2 workers are expected to be
supporting each beneficiary by 2040. (See fig. 9.)

               Figure 9: Social Security Workers per Beneficiary

3. When does the money run out?

The Social Security trust funds are projected to be able to pay full
benefits until 2041.2 Today baby boomers are still all of working age, and
annual Social Security trust fund income exceeds benefit payments. This
annual cash surplus is expected to continue until 2017 and help build up
the trust fund balances. After that time, annual benefit payments are
expected to exceed income, but interest income will more than make up the
difference. (See fig. 10.) Beginning in 2027,Trust fund balances are
expected to then decline rapidly until they are exhausted in 2041. At that
time, annual income will only be sufficient to pay about 74 percent of
promised benefits. By 2079, income will only be sufficient to pay about 68
percent of promised benefits.

The Congressional Budget Office (CBO) projects that the Social Security
trust funds will be able to pay full benefits until 2052. The differences
between the CBO and the Social Security trustees' estimates reflect
differences in both economic assumptions and projection methodology. The
CBO methodology uses a different approach for capturing and describing the
uncertainty of future outcomes. However, both the CBO and the trustees'
projections point to the same conclusion: that future Social Security
deficits will be large and growing over the long term. See Congressional
Budget Office, The Outlook for Social Security. Washington, D.C., June
2004.

Figure 10: Social Security's Trust Fund Balance Grows but then Declines
Rapidly after 2027

4. How big is the funding gap in dollars?

Actuaries have a variety of ways of answering this question. One approach
gives an answer of $4 trillion, another approach gives an answer of $11.1
trillion, and yet a third approach gives an answer of $12 trillion, each
in net present value. What's the difference? The estimate of $4 trillion
represents the additional amount needed today, which along with the
program's annual tax revenues and earnings on the trust fund balances
would suffice to pay all the projected annual costs over the next 75
years.3 This is how much it would cost in 2005 dollars to restore 75-year
solvency. This approach to measuring the funding gap reflects the adequacy
of financing for a pay-as-you-go system. The estimate of $11.1 trillion
represents the same difference between costs and income, except over an
infinite time horizon.4

The estimate of $12 trillion reflects a change from the current
pay-as-you-go system to a system that is fully advance funded. This figure
is the additional amount needed today, which along with lifetime payroll
tax contributions and earnings on the trust fund balances would suffice to
pay

3

Actuaries call this the open-group unfunded obligation.

4

Significant uncertainty surrounds any long-term projection. Therefore, the
focus should not be on the estimate itself, but rather what the estimates
can achieve in terms of solvency.

benefits for all those who are already participants in 2005.5By
"participants" we include all those who are 15 or older and, thus, have
already contributed to the system as of 2005 but exclude any future
workers and beneficiaries who have not yet contributed. For a fully
advance funded program, this value would equal zero.

In other words, $12 trillion is the value of benefits that past and
current participants will receive that exceeds what they will have paid
for. It largely reflects the large transfers already made to earlier
generations in the start up phase of a pay-as-you-go system. By its
nature, a pay-as-you-go system will always have a large unfunded
obligation. However, in a pay-as-you-go system, to the extent that future
generations are willing and able to pay more in taxes, this unfunded
liability can be rolled over from generation to generation indefinitely.

5. Which horizon should we be looking at: 75 years or an infinite horizon?

Both. Each horizon is helpful, providing useful but different information.
However, a horizon is not as important to focus on as the concept of
sustainability, and on this point each horizon leads to the same
conclusion. As figure 6 shows, the gap between costs and income continues
to widen through the end of the 75-year period. As each year passes,
another deficit year gets factored into the solvency estimate and makes it
worse. So even if we restored solvency over the next 75 years, we would
only face another 75year deficit next year. Sustainable solvency would
require finding a solution that would eliminate the gap between costs and
income on a continuing basis beyond the 75-year period. Using an infinite
horizon is one way to look at sustainability beyond the 75-year period.
Another way to look at sustainability would be to examine the trend in
costs versus income beyond the 75 years. Still another way would be to
examine the share of the budget and the economy that Social Security
consumes.

Historically, the question of the appropriate time horizon has shifted
back and forth. The 1965 Advisory Council on Social Security criticized
previous efforts to use an infinite horizon, saying that it "serves no
useful purpose;" it suggested using the current 75-year horizon. In
contrast, the 2003

Actuaries call this the closed-group unfunded obligation.

Technical Panel on Assumptions and Methods endorsed using the infinite
horizon in addition to the 75-year horizon. Still, the panel advised that
the methodologies for the infinite horizon needed to be carefully
examined.6 The technical panel further indicated that, referring to
estimates from the 2003 trustees' report, the $10.5 trillion estimate is a
"large figure" but that it needed to be seen in the context of the present
value of taxable payroll over the infinite horizon, which is on the order
of $275 trillion. The panel also believed that infinite horizon
projections should emphasize the measure as a percentage of taxable
payroll.7

According to the 2005 trustees' report, over the 75-year horizon the
unfunded obligation equals 1.8 percent of taxable payroll, while over an
infinite horizon it equals 3.5 percent of taxable payroll. In other words,
an immediate increase in the payroll tax of 1.8 percent would restore
solvency over the next 75 years, while an immediate increase of 3.5
percent would restore solvency over an infinite horizon, given current
assumptions.

No matter which horizon you use or how you look at sustainability, it is
important to keep in mind that estimating future outcomes is inherently
difficult, and using different assumptions can dramatically alter the
estimates. Therefore, in evaluating Social Security reform proposals, it
is helpful to focus on the differences between the proposals rather than
on the precise values of the estimates for any one scenario. Focusing on
the differences helps neutralize the limitations of the assumptions used.

6. Are there any issues other than solvency that call for reform?

In recent years, reform proposals have contained a variety of provisions
to address concerns other than restoring long-term solvency. Such concerns
include

     o mitigating persistent poverty among very elderly widows and those with
       low lifetime earnings;
     o making Social Security coverage universal, that is, covering

6

Technical Panel on Assumptions and Methods (2003). Report to the Social
Security Advisory Board. Washington, D.C., October 2003, pp. 84-85. This
marked a change from the 1965 Advisory Council on Social Security, which
rejected the issue of an infinite horizon in formulating projections. See
Advisory Council on Social Security, The Status of the Social Security
Program and Recommendations for Its Improvement, Washington D.C. 1965 at
http://www.ssa.gov/history/ reports/65council/65part1.html.

7

Technical Panel on Assumptions and Methods (2003). Report to the Social
Security Advisory Board. Washington, D.C., October 2003, pp. 87-88.

jobs that are not currently covered, such as some state and local
government jobs; and

o  redressing the effects of increasing earnings inequality on the
program's distributional outcomes.

                      OVERALL FISCAL AND ECONOMIC OUTLOOK

7. When Social Security's benefit payments exceed its income, where will
the money come from?

Absent other changes, benefit costs will exceed income in 2017. The trust
funds will have large reserves, plus interest income on these reserves, to
help pay benefits, but benefits must be paid in cash, not in government
securities. Starting in 2017, the Treasury Department will begin to redeem
trust fund securities in order to continue to pay full promised benefits.
Specifically, in order to convert the Trust Fund securities into cash, the
government will require increased government revenue, increased borrowing
from the public, or reduced spending in the rest of the government.8 So,
even though the trust funds will be able to pay full Social Security
benefits until 2041, redeeming their Treasury securities will have an
adverse impact on the federal budget much sooner. In fact, in 2009, Social
Security's cash surplus starts to decline. To finance the same level of
federal spending as in the previous year, the federal budget will need
additional revenues and/or increased borrowing, since Social Security's
surplus partially offsets the deficit in the rest of the government's
accounts. Assuming no additional revenues or spending cuts, budget
deficits for the federal government as a whole will increase.

Ultimately, the critical question is not how much the OASDI trust fund has
in assets. Rather, it is whether the government as a whole can afford to
pay the benefits in the future, and how those benefits compete with other
claims on scarce resources? Furthermore, what is the capacity of the
economy and budget to afford the commitment?

For more detail about the temporary trust fund buildup and how it
interacts with the federalbudget, see GAO, Social Security Financing:
Implications of Government Stock Investing forthe Trust Fund, the Federal
Budget, and the Economy, GAO/AIMD/HEHS-98-74 (Washington, D.C.: Apr. 22,
1998); GAO, Social Security Reform: Demographic Trends Underlie Long-Term
Financing Shortage, GAO/T-HEHS-98-43 (Washington, D.C.: Nov. 20, 1997).

8. What is the outlook for the whole federal budget and its capacity to
pay benefits, especially when Medicare and Medicaid are included?

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. 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. For example, increases in the number and
quality of health care services have been fueled by the explosive growth
of medical technology.9 This growth in spending on federal entitlements
for retirees will become increasingly unsustainable over the long term.
The increasing fiscal pressure will reduce budgetary flexibility further.
Over the past few decades, spending on mandatory programs-entitlement
programs such as Social Security and Medicare-has consumed an increasing
share of the federal budget. In 1964, prior to the creation of the
Medicare and Medicaid programs, spending for mandatory programs plus net
interest accounted for about 33 percent of total federal spending.10 By
2004, this share had almost doubled to approximately 61 percent of the
budget. (See fig. 11.)

9

GAO has developed a health care framework to help focus attention on this
important area and tohelp educate key policy makers and the public on the
current system and related challenges. GAO's health care framework can be
found at www.gao.gov/cghome/hccrisis/health.pdf. See also GAO, Comptroller
General's Forum on Health Care: Unsustainable Trends Necessitate
Comprehensive and Fundamental Reforms to Control Spending and Improve
Value, GAO-04-793SP (Washington, D. C.: May 1, 2004).

10

Net interest is primarily interest on debt held by the public but also
includes interest earned fromother sources and interest paid for purposes
other than borrowing from the public.

Note: Discretionary programs are those programs controlled by Congress
through the annual appropriations process. They include a wide range of
program such as defense, environmental, education and other programs.

Moreover, our nation faces growing budget deficits and interest costs.
Assuming, for example, that all expiring tax provisions are extended and
discretionary spending keeps pace with the economy, by 2040 total federal
revenues may be adequate to pay no more than interest on the federal debt.
(See fig. 12.) To obtain balance, massive spending cuts, tax increases, or
some combination of the two would be necessary. Slowing the growth of
discretionary spending and allowing the tax reductions to sunset will not
eliminate the imbalance.11

For additional discussion of our budget simulations, see GAO, Our Nation's
Fiscal Outlook: The Federal Government's Long-Term Budget Imbalance, at
http://www.gao.gov/special.pubs/longterm/ longterm.html.

2015 due to (1) real bracket creep, (2) more taxpayers becoming subject to
the AMT, and (3) increased revenue from tax-deferred retirement accounts.
After 2015, revenue as a share of GDP is held constant.

9. What are the implications of this budgetary outlook for the economy as
a whole?

Figure 13 shows the total future draw on the economy represented by Social
Security, Medicare, and Medicaid. Under the 2005 Trustees' intermediate
estimates and CBO's long-term Medicaid estimates, spending for these
entitlement programs combined will grow to 15.2 percent of GDP in 2030
from today's 8.5 percent. Taken together, Social Security, Medicare, and
Medicaid represent an unsustainable burden on future generations.

2005 trustees' reports. Medicaid projections are based on CBO's January
2005 short-term Medicaid estimates and CBO's December 2003 long-term
Medicaid projections under midrange assumptions.

Although higher economic growth could help ease budgetary pressures, the
fiscal gap is simply too large for us to grow our way out of the problem.
Demographic trends and low national saving rates suggest that higher
economic growth, which is fueled by increases in labor, investment, and
productivity, will be difficult to achieve. As shown in figure 8 earlier,
growth of the labor force is expected to slow dramatically and by 2025 is
expected to be less than a third of what it is today.

Increased investment could spur economic growth. However, increasing
investment depends, at least in part, on national saving. One component of
national saving, personal saving, remains at historically low levels (See
Figure 14). Traditionally, the most direct way for the federal government
to increase saving has been to reduce the deficit (or run a surplus).
Although the government may try to increase personal saving, results of
these efforts have been mixed. For example, even with the preferential tax
treatment granted since the 1970s to encourage retirement saving, the
personal saving rate has steadily declined.

              Figure 14: Annual Personal Saving Rates, 1960 - 2004

  CONSEQUENCES OF INACTION

10. Why can't we wait for a more immediate solvency crisis to reform
Social Security?

Waiting until Social Security faces an immediate solvency crisis could
reduce the options to only those choices that are the most difficult.
Acting soon would allow changes to be smaller and to be phased in so the
individuals who are most likely to be affected, namely younger and future
workers, will have more time to adjust their retirement planning. In
addition, acting soon reduces the likelihood that Congress will have to
choose between imposing severe benefit cuts and unfairly burdening future
generations with the program's rising costs. Taking action soon would also
promote increased budgetary flexibility in the future, which could lead to
greater investment, productivity, and stronger economic growth.
Asuccessful reform effort would improve government credibility and enhance
confidence in key financial markets. Even if reforms succeed in increasing
national saving, it would take many years for any resulting economic
growth to fully develop.

Acting soon would also help to ensure that the "miracle of compounding"
works for us rather than against us. Increasing trust fund balances sooner
means they have more time to build up with compound interest. Conversely,
reducing the publicly held debt reduces the compound interest payments
that taxpayers make on that debt. Some of the benefits of early action-and
the costs of delay-can be seen in figure 15. This figure compares what it
would take to achieve solvency at different points in time by either
raising payroll taxes or reducing benefits.12 If we did nothing until
2041-the year the Trust Funds are estimated to be exhausted-achieving
actuarial balance would require an average reduction in benefits of 29
percent or an increase in taxes of 41 percent, or an equivalent
combination of benefit reductions and tax increases for the period
2041-2079. As figure 15 shows, earlier action shrinks the size of the
adjustment that would be needed now and in the future.

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 with changes made exclusively to taxes or benefits as
shown in figure 15.

11. But what happens if we don't do anything?

If we don't do anything, the system will likely become insolvent and pay
lower benefits; it will not, though, go bankrupt.13 However, because the
law does not provide for any procedure for paying less than full benefits,
it is difficult to say exactly what would unfold. One possible scenario of
trust fund exhaustion underscores the need to take action sooner rather
than later.14 Under this scenario, full benefits promised under current
law would be paid until trust fund exhaustion. After that date, benefit
payments would be adjusted each year to equal annual tax income.
Initially, benefits for all Social Security recipients would be reduced
across the board to 74 percent

13

The Social Security Act does not address what would happen if the trust
funds become exhausted.

14

This trust fund exhaustion scenario is intended as an analytic tool, not a
legal determination.See GAO, Social Security Reform: Analysis of a Trust
Fund Exhaustion Scenario, GAO-03-907 (Washington, D.C.: July 29, 2003).

of currently scheduled levels. Additional reductions would need to be
taken in successive years; by the end of the 75-year projection period,
benefits would be only 68 percent of currently scheduled levels.

This trust fund exhaustion scenario raises significant intergenerational
equity issues. Specifically, a much greater burden would be placed on
younger generations than under policy scenarios that are phased in over
longer periods. Also benefits would be adjusted proportionately for all
recipients, increasing the likelihood of hardship for lower-income
retirees and the disabled.

  A FRAMEWORK FOR EVALUATION

12. How should we evaluate the various options for Social Security reform?

The Social Security 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. There are many options and trade-offs that
need to be considered. Thus, GAO has developed a broad framework for
evaluating reform proposals that considers not only solvency but other
aspects of the program as well. Specifically, the framework uses three
basic criteria:

     o the extent to which a proposal achieves sustainable solvency and how
       it would affect the economy and the federal budget;
     o the relative balance struck between the goals of individual equity and
       income adequacy; and
     o how readily a proposal could be implemented, administered, and
       explained to the public.

The weight that different policy makers may place on different criteria
will vary, depending on how they value different attributes. For example,
if policy makers determine that offering individual choice and control is
a primary concern, then a reform proposal emphasizing individual equity
considerations might be preferred. Alternatively, if policymakers
determine that benefit certainty and security are of primary concern, then
reform proposals that stress adequacy and sustainable solvency might be
preferred. As they fashion a comprehensive proposal, however, policy
makers will ultimately have to balance the relative importance they place
on each of these criteria.

13. Why do we hear claims about the effects of proposals that directly
contradict each other?

In examining the effect of possible reforms to Social Security, many
analysts use so-called benchmarks as standards of comparison. For example,
discussions of a reform proposal might discuss the size of benefit changes
resulting from the reforms. However, calculations of benefit changes use
some benchmark that assumes something about what the benefit levels would
be in the absence of reform, implicitly or explicitly. Analysts use
benchmarks to reflect certain aspects of the existing system that they
deem important. Because of Social Security's long-term insolvency, what
benefit levels will be in the absence of reform is not at all clear.
Revenue increases or benefit reductions, or some combination of the two,
will be necessary to restore solvency. Proponents or opponents of a
particular reform might well like to calculate benefit changes using a
benchmark that is most favorable to their position. So it is possible to
have proponents and opponents discussing exactly the same reform proposal
but claiming two totally different estimates of what the benefit changes
would be. Basing their analyses on different benchmarks would lead to such
contradictory results. This can be a source of great confusion.

14. What benchmarks should be used for comparison?

Acknowledging the sensitivity of this issue, GAO evaluations compare
proposals to at least two consistent benchmarks that would reflect a
solvent system. One benchmark illustrates the most that we would expect
benefits to be, while the other illustrates the least that benefits could
be. The most that benefits could be would result from restoring solvency
by increasing taxes but leaving current benefits untouched. We call these
"promised benefits" because they reflect the benefits promised under the
existing benefit formula. In contrast, the least that benefits could be
would result from restoring solvency only through benefit reductions and
leaving taxes untouched. We call these "funded benefits" because they
reflect the benefit levels that existing revenues would be able to fund.
Still, benefits could be reduced in a variety of ways under such a
benchmark.15

For more information about the benchmarks, see app. I of GAO, Social
Security: Distribution ofBenefits and Taxes Relative to Earnings Level,
GAO-04-747 (Washington, D.C.: June 15, 2004).

In particular, the timing of any policy changes in a benchmark scenario
should be consistent with the proposals against which the benchmark is
compared. For example, the analysis of most proposals assumes that the
proposal is enacted fairly soon, usually within a few years. A benchmark
would be consistent with such a proposal if the timing of its policy
changes were comparable to the timing of policy changes in the proposal.
So, for example, it would not be consistent to compare a proposal that
takes effect soon with a benchmark whose policy changes do not take effect
for many years.

What are the options for Social Security reform?

                                      III.

A wide variety of options for reform have been proposed. In providing an
overview of the possibilities for reform, this section attempts to list
and describe the range of options individually. However, reform proposals
generally package several options together, and the various options can
interact with and tend to balance or offset one another. Evaluating
complete proposals as packages of various options helps capture such
interactions.

Options for reforming Social Security generally fall into three broad
groups:

     o changing benefits,
     o changing revenues, and
     o changing the program structure with new individual accounts.

Some of the reform options focus on restoring Social Security's long-term
solvency. However, a few aim to enhance benefits for specific groups, such
as widows and low earners who are especially at risk of poverty. Often,
such enhancements are packaged along with benefit reductions for middle
and higher level earners. Also, changing the structure of the program with
individual accounts will not, by themselves, achieve solvency. Such
approaches generally aim to help move the program toward funding benefit
promises in advance and giving individuals the possibility to earn higher
returns on their contributions. Since the individual accounts do not
result in sustainable solvency, they are often packaged with other benefit
reduction or revenue enhancement options that as a package do achieve
sustainable solvency.

CHANGING BENEFITS

1. What are ways of changing the benefit formula?

As described in section 1, Social Security uses a multifaceted formula to
determine initial benefits. This formula can be modified in various ways,
either to reduce benefits or to enhance benefits for particular
beneficiaries. Such ways include

o  Changing the factors in the formula that determine what percentage of
each worker's average monthly lifetime earnings are replaced.

The current benefit formula replaces 90 percent of average indexed
earnings up to a certain dollar threshold, 32 percent of average indexed
earnings above that threshold and below a second threshold, and 15 percent
of average indexed earnings above the second threshold (see fig. 16).
These replacement percentages could be reduced in a variety of amounts and
combinations. Also, additional thresholds could be added, and different
replacement percentages would apply to the new segments of average
earnings that result from the new thresholds.

Figure 16: Social Security Benefit Formula Replaces Earnings at Different
Rates

o  Indexing the lifetime earnings used in the formula by prices instead of
wages. Under the current formula, the determination of initial benefits
includes a calculation of the worker's total covered earnings received
over his or her lifetime, indexed or corrected for the growth in wages
over that time period. In the past, wages have grown faster than prices
and are expected to continue to be greater than increases in prices in the
future as well. Indexing to prices rather than wages, commonly implemented
by modifying the replacement percentages, would reduce benefits. In
practical terms, doing so would result in a proportional benefit reduction
across all earnings levels. However, this could also be formulated in a
progressive manner, where only those individuals above a certain income
level would be subject to price indexing.

o  Indexing the benefit formula to reflect improvements in longevity.

If people live longer in retirement and collect benefits for more years,
the cost of those benefits increases. Indexing the benefit formula to
reflect improvements in the average life span of the population could be
used to keep the cost of lifetime benefits the same as people live longer.
Indexing benefits to such improvements in longevity would be similar to
increasing the full retirement age, as workers would have to retire at an
older age to get the same benefit as they would under the current full
retirement age. In practical terms, modifying the benefit formula in this
manner would result in a proportional benefit reduction across all
earnings levels.

     o Changing the number of working years over which annual earnings are
       averaged. Under the current benefit formula, the calculation of the
       worker's total covered earnings received over his or her lifetime is
       based on the highest 35 years of that worker's earnings. Since many
       workers have earnings in more that 35 years, the current formula
       permits a higher benefit because workers are able to exclude their
       lowest earning years from this calculation. Including more of these
       lower-earning years into the calculation would reduce the average
       lifetime earnings, which, in turn, would reduce benefits as compared
       to current levels. On the other hand, decreasing the number of years
       used in the benefit formula, for example, to exclude years when women
       are out of the labor force having children, would eliminate additional
       years in which they had lower or no earnings, and in turn increase
       benefits for these workers.
     o Modifying factors used to determine benefits for spouses and
       widow(er)s. Under the current system, widows or widowers receive
       benefits that can vary from 50 to 67 percent of the benefit the
       couples received while both spouses were living, depending on the work
       records of both spouses. The percentage of the worker's benefit that
       spouses and widow(er)s receive could be altered to boost the benefits
       of widow(er)s, who are at especially high risk of poverty.
     o Reintroducing minimum benefit amounts. Before 1981, Social Security
       had minimum benefit levels. Some proposals would establish new
       minimums, for example, for workers who work a certain number of years
       with earnings greater than or equal to the minimum wage. This would be
       a benefit increase targeting lower earners, who are at especially high
       risk of poverty.
     o Modifying adjustments for early or delayed retirement. Currently,
       benefits are reduced for workers who retire before the full retirement
       age and increased for those who retire after that age. These
       adjustments could be modified to reduce benefits even more for workers
       who retire before the full retirement age or increase benefits more
       for those who delay retirement.

2. How could COLAs be reduced?

Each year, monthly benefits being paid out are increased to keep pace with
inflation using a cost-of-living adjustment (COLA). The COLA is based on
the consumer price index (CPI). Studies have found that the CPI overstates
the true rate of inflation, which would make these COLAs higher than
necessary to keep pace with inflation.1 Any such errors in COLAs can be
especially expensive since they have a cumulative effect. For the same
reason, the effect of changes increases as beneficiaries age. COLA
reductions would reduce estimated future benefit costs immediately, and
they would affect both current and future beneficiaries. COLAs could also
be used simply to reduce benefits, as for example, lowering the COLA to
less than the CPI, limiting the COLA to a specified threshold, or delaying
the COLA.

For more information on the CPI and how it overstates the true rate of
inflation, see Advisory Commission to Study the Consumer Price Index,
"Toward a More Accurate Measure of the Cost of Living," Final Report to
the Senate Committee on Finance, Dec. 1996; Brent R. Moulton, "Bias in the
Consumer Price Index: What Is the Evidence?," Journal of Economic
Perspectives, Vol. 10, No. 4, 1996, pp.159-177; Congressional Budget
Office, Is the Growth of the CPI a Biased Measure of Changes in the Cost
of Living? (Washington, D.C., 1994).

3. How would increasing the retirement age work?

Social Security pays full benefits at the full retirement age. Until
recently, the full retirement age was 65. Under reforms enacted in 1983,
the full retirement age is gradually increasing to 67. Workers are
eligible to start receiving retirement benefits at age 62, but the
benefits are reduced because workers retiring early receive their monthly
benefits for more years. Workers who retire after the full retirement age
receive a credit that increases their monthly benefits because they
receive benefits over fewer years.

One option for reform would be to increase the full retirement age
further. Doing so has the effect of reducing benefits proportionally
across all earnings levels. For any given age at which a worker retires,
their benefits will be lower than if the full retirement age had not been
increased. However, an increase in the full retirement age could increase
disability applications, especially workers in certain occupations (e.g.,
construction) who may not be able to work longer.

Another option would be to increase the earliest eligibility age. However,
if no changes were made to the full retirement age and early retirement
adjustments, lifetime benefits for those reaching the new early retirement
age would not be affected significantly. Some workers who would have
retired before age 65, however, may still qualify for Social Security
under the Disability Insurance program.

CHANGING REVENUES

4. What are the options for increasing tax revenues?

There are a variety of options for increasing tax revenues, most of which
can be done independently or together as part of a package. These options
include:

o  Raising the Social Security payroll tax rate. Until 1978, raising
revenues by increasing the OASDI payroll tax rate paid by workers and
their employers occurred quite regularly.2 The 1977 amendments to the
Social Security Act raised the OASDI rate for workers and employers to 6.2
percent, effective in 1990. The

The OASDI tax rate was initially set at 1 percent of the first $3,000 of
earnings for both the employee and the employer. The rate increased 20
times between 1937, when the tax was first collected, and 1990, when the
rate reached its current level. Higher rates were not needed early inthe
program, when relatively few of the elderly qualified for benefits. The
tax rate increases were always anticipated as part of the maturing of the
pay-as-you-go program.

1983 amendments increased the payroll tax rate for the self-employed,
raising it to 12.4 percent by 1990. No future increases are scheduled.

     o Raising the cap on taxable earnings. In 2005, earnings above $90,000
       are not subject to payroll taxes. This amount increases each year to
       keep pace with the growth in average wages. If the cap was raised and
       the benefit formula remained the same, workers with earnings above the
       old cap would ultimately receive somewhat higher benefits as well as
       pay more taxes.
     o Covering all employment. Today, Social Security covers and collects
       payroll taxes from about 96 percent of the workforce. The vast
       majority of the remaining uncovered workers are state, local, and
       federal government employees.3 Covering all the remaining workers
       increases revenues relatively quickly and improves solvency for some
       time, since most of the newly covered workers would not receive
       benefits for many years. In the long run, however, benefit payments
       would increase as the newly covered workers started to collect
       benefits. Overall, this change would still represent a net gain for
       solvency, although it would be small.

5. Are there other ways to increase Social Security's revenues?

Social security can obtain revenues from sources currently outside of the
program. These include:

     o Transferring revenues from the Treasury's general fund. General
       revenue transfers could partially fund the system with money from
       other government revenue sources. Such transfers would ultimately be
       financed either by reducing other government spending, increasing
       taxes, or borrowing from the public.
     o Adding a new revenue stream. A new revenue source could be earmarked
       for Social Security, as was done by the 1983 amendments, which
       extended the income tax to a portion of Social Security benefits for
       higher income beneficiaries and earmarked the funds for Social
       Security.

About one-fourth of public employees do not pay Social Security taxes on
the earnings from theirgovernment jobs. Extending Social Security's
coverage to include them could result in potentially significant
transition costs for some of their state and local government employers.
See GAO, Social Security: Implications of Extending Mandatory Coverage to
State and Local GovernmentEmployees, GAO/HEHS-98-196 (Washington, D.C.:
Aug. 18, 1998).

o  Increasing the investment returns on Social Security holdings.

Currently, by law, the trust funds are invested in Treasury securities
that earn a relatively low, safe rate of return. Investing a portion of
Social Security trust funds in private sector securities could increase
investment returns but also increase investment risk.4 Under a new system
of individual accounts that draw from Social Security contributions,
individuals could also invest in the stock market, potentially increasing
investment returns while assuming increased investment risk.

CHANGING THE PROGRAM'S STRUCTURE WITH INDIVIDUAL ACCOUNTS

Some reform advocates have suggested the use of individual investment
accounts as a component of Social Security reform. Individual accounts are
usually associated with two key elements: advance-funding of retirement
income through investment in private financial assets, greater individual
control of decisions about investing those assets, and individuals
assuming the risk associated with such investments. Depending on the
proposal, these accounts would replace part of the current Social Security
benefit or they would supplement it. A system of individual accounts,
especially if they replace a part of the Social Security benefit, would
constitute a fundamental change to Social Security and could be
significantly larger than any existing retirement investment program. In
addition to the question of how to administer and manage the accounts,
provisions of individual account proposals can be grouped in three
categories corresponding to different phases of the life of the accounts:

     o Contribution phase: This includes the decision of whether to
       participate in the accounts at all, how much is contributed to the
       accounts, and where the contributions come from.
     o Accumulation phase: This includes how account assets are invested and
       built up and whether the benefits from the accounts are guaranteed to
       match the current system.
     o Distribution phase: This includes how account balances are drawn down
       and whether funds can be accessed before retirement for any reason.

GAO, Social Security Financing: Implications of Government Stock Investing
for the Trust Fund, the Federal Budget, and the Economy,
GAO/AIMD/HEHS-98-74 (Washington, D.C.: Apr. 22, 1998).

6. Who would manage the accounts?

A system of individual accounts would require administrative, investment
and record-keeping tasks covering all three phases of the life of each
account. These tasks could be performed in a system that ranges from very
centralized to very decentralized, with varying levels of involvement by
government agencies, employers, financial institutions, and individuals.
An example of a largely centralized system is the Thrift Savings Plan,
which is a retirement savings plan for federal employees, including
members of the Congress. An example of a largely decentralized system is
the existing system of individual retirement accounts (IRAs), which are
tax-deductible individual accounts for individuals.

7. Would accounts be required for Social Security participants?

The first step in the contribution phase of an individual account system
would be to determine who participates in the accounts. Some proposals
would make participation mandatory, while others would make it voluntary.
Voluntary systems further vary depending on whether workers have a onetime
choice to participate or can opt in and opt out more than once over their
careers. In general, greater choice would involve greater complexity and
cost.5 For example, voluntary plans sometimes offer incentives to
participate, while mandatory plans do not need them. Voluntary plans would
also require greater educational efforts to help workers make informed
choices about choosing whether and to what extent to participate.

8. How much would go into the accounts?

An individual account plan can provide for contributions in a variety of
ways. For example, a plan might set contributions at a fixed rate, such as
2 percent of pay, or allow a range of rates up to a certain dollar amount.
Some proposals provide for greater average contribution rates for lower
earners than for higher earners. For example, contribution rates may go
down gradually as earnings rise, or alternatively, all workers might pay a
fixed percentage but have a dollar cap on contribution amounts. Also,
contributions might be collected and deposited by the government in a
centralized process or by employers or account providers in a
decentralized process.

GAO, Social Security Reform: Information on Using a Voluntary Approach to
Individual Accounts, GAO-03-309 (Washington, D.C.: Mar. 10, 2003).

9. What's the difference between an add-on and a carve-out account?

Individual accounts can either supplement the current Social Security
program (add-on) or substitute for all or part of it (carve-out).6 With
add-on accounts, the account and contributions to it have no effect on the
Social Security benefit but would require contributions and would offer
benefits in addition to the current Social Security program. With
carve-out accounts, the Social Security benefit is reduced (or offset) in
some way to account for contributions that have been carved out, or
diverted, from the current Social Security program. The accounts then
offer the potential for making up for or exceeding that offset.

10. What are transition costs?

Under various proposals, contributions to the new accounts could come from
either existing payroll tax revenues, increased contribution rates, or
general revenue transfers.

In the case of carve-out accounts, however, existing payroll taxes are not
adequate to pay for promised Social Security benefits, much less for new
account contributions. Making account deposits while also meeting current
benefit costs requires additional revenue, which we refer to as transition
costs. Depending on the underlying assumptions and the specifics of the
proposals, these costs generally range from less than $1 trillion to more
than $2 trillion over the next 75 years, in today's dollars. Typically,
proposals finance these transition costs with general revenue transfers
elsewhere in the budget. In turn, general revenue transfers require
decreased government spending, increased revenues, or increased borrowing
from the public. Eventually the system becomes stable and there are no
more transition costs. However, this could be many years in the future.

Under an add-on account plan, transition costs would not be an issue
because no resources are diverted from paying current benefits, though
such

In GAO's work to date, we have used the term "add-on" accounts to refer to
accounts that would have no effect on Social Security benefits, would
supplement those benefits, and would draw contributions from new revenue
streams. In contrast, we have used the term "carve-out" accounts to refer
to accounts that would result in some reduction or offset to Social
Security benefits because contributions to those accounts would draw on
existing Social Security revenues. Others have used these terms in
different manners. For example, some have used "add-ons" in connection
with newindividual accounts funded from new revenue sources that result in
a reduction or offset to some or all Social Security benefits. In the
final analysis, there are two key dimensions: first, whether individual
accounts are funded from existing or new revenue sources; second, whether
individualaccounts result in some reduction or offset to Social Security
benefits.

plans do require additional contributions. These additional contributions
could come from an increase in the payroll tax, directly from individuals
or from general revenue.

11. What investment options would there be?

With respect to the accumulation phase, individual account plans have
provisions regarding the range of investment choices participants have.
Some proposals allow individuals wide latitude in investment options;
others provide a narrower choice, generally between stock and bond mutual
funds, and particular types of mutual funds.7For example, the federal
government's Thrift Savings Plan permits federal employees to choose among
five different investment options, including Treasury bonds, a corporate
bond index fund, an equities index fund, an international and small
business index options.

12. How would participants draw on the accounts for retirement income?

With respect to the distribution phase, individual account systems
generally use three basic ways to pay retirement benefits: annuitization,
timed withdrawals, and lump sum payments. Under a system of annuities,
retirees would receive monthly payments for an agreed-upon length of time,
and the size of those payments would depend on the total value of the
individual accounts. Under individual account proposals, annuities would
be obtained either through government agencies or the private market. Some
proposals would make annuitization mandatory to help ensure that the
accounts provided retirement income for the entire remaining lifetimes of
participants.

Other options for the payout of accounts include timed withdrawals (also
referred to as self-annuitization) and lump sum payments. In a timed
withdrawal, retirees specify a withdrawal schedule with the investment
manager or record keeper. Each month, they receive their predetermined
amount, while the balance of the individual account remains invested.
Under a lump sum payment option, individuals may liquidate their accounts
through a single payment at retirement and choose to spend or save their
money according to their needs or desires.

Mutual funds pool the limited funds of small investors into large amounts,
thereby gaining the advantages of large-scale trading. Investors are
assigned a prorated share of the total fundsaccording to the size of their
investments.

13. Would participants have any guarantee of doing better than under the
current system?

To address concerns individuals may have about investment risk, some
individual account plans offer guarantees that benefits will reach a
certain level. Under a voluntary approach, such guarantees are intended to
encourage participation. However, even some mandatory plans have offered
guarantees. Guarantees can take a variety of forms. For example, some
proposals would guarantee that Social Security beneficiaries would receive
total monthly benefits-the traditional benefit plus the account-at least
as high as those currently promised.8 Some other nations with an
individual account feature in their national pension systems provide for a
more minimal guarantee on their accounts. Germany, for example, requires
that account providers return to participants on withdrawal an amount at
least equal to the nominal9 contributions participants made to their
accounts.10

8

See GAO, Social Security Reform: Information on the Archer-Shaw Proposal,
GAO/AIMD/ HEHS-00-56 (Washington, D.C.: Jan. 18, 2000); GAO, Social
Security: Reform Proposals Could Have a Variety of Effects on Distribution
of Benefits and Payroll Taxes, GAO-04-872T (Washington, D.C.: June 15,
2004).

9

This amount is not adjusted for inflation; rather it is just the dollar
amount the individual contributed.

10

For more information on the international experience with individual
accounts, includingGermany, see GAO, Social Security Reform: Information
on Using a Voluntary Approach to Individual Accounts, GAO-03-309
(Washington, D.C.: Mar. 10, 2003).

What are the implications of Social Security Reform?

IV.

  CHANGING BENEFITS OR REVENUE

1. What will achieving sustainable solvency require?

Restoring solvency for the long term requires that either Social Security
gets additional income (revenue increases), reduces costs (benefit
reductions), or undertakes some combination of the two. The sooner action
is taken, the smaller the magnitude of changes that will be necessary to
achieve solvency. If changes were enacted today, achieving solvency would
require either benefit reductions of 13 percent or tax increases of 15
percent. If no changes were made until 2041-the year the trust funds are
estimated to be exhausted-achieving solvency for the period 2041 through
2079 would require reductions in benefits of 29 percent or increases in
taxes of 41 percent. Funding the current system of scheduled benefits and
taxes over the next 75 years would require $4 trillion today.1 While it is
possible to make the system solvent over a 75-year period, doing so does
not solve the problem. It only ensures that projected revenues equal
projected outlays over the 75-year period. Solutions that lead to
sustainable solvency are those that avoid the need to periodically revisit
this difficult issue.2

2. What effects do these options have on the overall federal budget and
the public debt?

Social Security reforms will affect the amount of cash necessary to pay
benefits. These cash requirements ultimately determine the effects on
federal budget deficits and the public debt. Regardless of the value of
government securities in the trust funds, benefits are paid in cash. When
Social Security's cash revenues are not sufficient to pay benefits, the
trust funds will exchange government securities for enough cash to cover
all promised benefits. Treasury will need to find that cash from decreased
spending in the rest of the budget, increased revenues, additional
government borrowing from the public, or some combination thereof.
Additional government borrowing from the public increases the unified
budget deficit and the public debt.3

1

Additional revenue, beyond the $4 trillion, would also be required in
order to repay the bonds inthe trust funds.

2

Funding the current system fully forever without cutting benefits or
raising taxes would require $11.1 trillion today. However, this would
change the financing structure of the system from pay-as-you-go to advance
funding.

3. Can Social Security reforms promote economic growth and worker
productivity?

As more people live longer in retirement, the costs of providing
retirement income will increase unless people retire later or collect
smaller benefits. At the same time, relatively fewer workers will be
producing the goods and services consumed by all. In the final analysis,
no matter what shape Social Security reforms take, those workers will need
to be more productive to keep up with the demand for goods and services or
we will need more workers. Ideally, Social Security reforms would
indirectly promote economic growth and worker productivity, by reducing
the strain on the budget. Reduced budgetary pressure could increase
national saving and allow greater spending on education, plants, and
equipment to make workers more productive.

4. How would benefit reductions affect the adequacy of benefits?

The Social Security program has played an important role in helping ensure
adequate incomes for its beneficiaries. One means of addressing Social
Security's solvency issue is to reduce benefits from those promised by
today's program. Benefits can be reduced in many different ways, but
regardless of the approach, benefit reductions will affect the adequacy of
benefits. However, certain approaches can have a bigger impact on the
adequacy of benefits for particular groups of beneficiaries. For example,
some benefit reductions take a proportional approach, reducing benefit
formula factors at the same rate across all earnings levels. In contrast,
some approaches would reduce benefits less for low earners than for high
earners. Also, some proposals enhance benefits for low earners in
combination with proportional reductions. The choice of benefit reduction
approaches will affect the adequacy of income in the future. A
proportional benefit reduction approach would have a greater number of
retired workers with benefits below the official poverty threshold than
under a non-proportional benefit reduction approach of equal financial
magnitude.

The effects of some reform options parallel those of benefit reductions
made through the benefit formula. For example, if workers were to retire
at a given age, an increase in Social Security's full retirement age would
result in a reduction in monthly benefits; moreover, that benefit
reduction

The unified budget deficit is the amount by which the government's
on-budget and off-budget outlays exceed the sum of its on-budget and
off-budget receipts. Public debt is federal debt held by all investors
outside of the federal government.

would be a proportional reduction. Another example would be indexing the
benefit formula to prices instead of wages, as is currently done, or
indexing benefits to future increases in life expectancy. Such changes
would also be proportional reductions because all earnings levels would be
treated the same under each approach.

A consequence of changing to price indexing could be that Social Security
benefits may not keep pace with improvements in the society's standard of
living. When wages grow faster than prices, workers can afford to consume
more goods and services, their purchasing power increases, and the
standard of living improves. Historically, wages have grown faster than
prices, on average. Since Social Security's current benefit formula is
indexed to wages, increases in initial benefits keep pace with
improvements in the standard of living. Indexing benefits to prices
instead of wages would make the purchasing power of benefits remain
constant even if wage growth were improving purchasing power for the rest
of society. In 1960, the standard of living was much lower than it is
today. In that year, the average monthly benefit for all retired workers
was $74.04. If the average monthly benefit in 2005 were the same, adjusted
for inflation, it would be $483.51. If it were adjusted for wage growth
instead, the $483.51 would be $676.26 today.

5. Does greater progressivity in benefits imply greater income adequacy?

To help ensure that beneficiaries have adequate incomes, Social Security's
benefit formula is designed to be progressive, that is, to provide
disproportionately larger benefits, as a percentage of earnings, to lower
earners than to higher earners. However, greater progressivity is not the
same thing as greater adequacy. Under some reform options, Social Security
could distribute benefits more progressively than current law yet provide
lower, less adequate benefits.4At the same time, reform provisions that
favor lower earners can offset other provisions that disfavor them. As a
result, any evaluations should consider a proposal's provisions taken
together as a whole.

GAO, Social Security: Distribution of Benefits and Taxes Relative to
Earnings Level, GAO-04-747 (Washington, D.C.: June 15, 2004).

6. What would happen to the adequacy of benefits for the disabled,
dependents, and survivors?

Social Security has substantially improved income adequacy for specific
subgroups of beneficiaries, such as minorities, women, single persons,
widows, and the disabled. However, even with those improvements,
significant levels of poverty remain, reflecting the generally lower
lifetime earnings and reduced access to other sources of retirement income
among such groups. A reform proposal's effect on adequacy for subgroups of
beneficiaries will depend on how it changes benefits for these subgroups.
Many proposals make changes to the overall benefit structure but do not
protect various subgroups. Therefore, a provision that reduces benefits
for retirees generally would, in many cases, also reduce benefits for
individuals with disabilities. However, the circumstances facing disabled
workers differ from those facing retired workers. For example, DI
beneficiaries enter the program at younger ages than other beneficiaries
and remain in the program in most cases until death. Thus, if the COLA was
reduced, disabled beneficiaries could be subject to reductions in benefits
for many more years than retirees, due to the cumulative effect of the
COLA. Some proposals also include features that might enhance benefits for
specific subgroups, such as low-income workers and surviving spouses,
which can have substantial improvements on their income adequacy.

7. How will individual equity be affected by these reform options?

The equity perspective focuses on whether, over their lifetimes,
beneficiaries can expect to receive a fair return on their contributions;
essentially whether or not they get their money's worth from the system.
By linking benefits to a worker's earnings through his or her payroll tax
contributions, Social Security also incorporates the principle of
individual equity. One can assess proposals for their effect on individual
equity, although in some cases this can be difficult. For proposals where
the financing of the reform is well defined, for example, an increase in
the payroll tax, equity can be assessed through looking at measures like
the ratio of expected benefits received to expected taxes paid.

In other cases, assessing a proposal for its effect on individual equity
can be more difficult, as, for example, when reform options involve
general revenue transfers. Such proposals typically do not specify how
such transfers are to be financed or who will eventually bear their
burden, yet general revenue transfers implicitly require future tax
increases, spending cuts in other parts of the budget, or a combination of
both, all of which have substantial distributional consequences. Without
knowing who will bear the costs of financing these transfers, the equity
perspective cannot accurately determine how well lower earners will fare
relative to higher earners in a given system or across proposed reforms.

8. What issues would arise in implementing these options?

Some degree of implementation and administrative complexity arises in
virtually all proposed changes to Social Security. However, regardless of
whether policy makers raise taxes or reduce benefits, or agree upon a
combination of these two approaches, how readily the changes can be
explained to the public and the amount of time individuals are given to
respond to the changes are important issues. A reasonable amount of time
will be required for the general public to readily understand the
financing and benefit structure of any changes. Individuals may also need
time to make adjustments to their retirement decisions based on these
changes. For example, individuals may decide they need to work longer, and
this decision may necessitate a career change. Therefore, an education
effort may be needed in order to increase public confidence and avoid
expectations gaps.

CHANGING THE PROGRAM'S STRUCTURE WITH INDIVIDUAL ACCOUNTS

9. Would individual accounts help achieve solvency?

There are many different ways that an individual account system could be
set up. However, individual accounts, whether voluntary or mandatory, or
whether structured as add-on benefits or as a carve-out from the current
system, would generally not by themselves achieve solvency. Achieving
solvency requires more revenue, lower benefits, or both. Add-on accounts
generally have no effect on the current Social Security benefit or the
financing of the system and, thus, have no direct effect on solvency.
Because carve out accounts have a negative effect on solvency, as compared
with the status quo, most proposals creating such accounts bundle them
together with a variety of other reform provisions, and it is the other
provisions that reduce benefits or increase revenues that effectively
achieve solvency. Thus, the role of individual accounts in reform plans is
generally not so much to achieve solvency for the current system as to
offer workers an opportunity to make up for the benefit reductions or
other changes that are included as part of the whole proposal. Depending
on their design, individual accounts can contribute to sustainability, by
providing a mechanism to prefund retirement benefits that would be immune
to demographic booms and busts. However, if these accounts are financed
through borrowing, prefunding will not be achieved until the additional
debt has been repaid, which is likely not to happen for many decades.

10. What would it cost to create a system with individual accounts?

Reform proposals with individual accounts would require substantial
additional revenues for a significant period after they are started. This
is because existing payroll taxes would be used both to finance the new
accounts and to pay benefits. These so-called transition costs are very
large; for example, they have been estimated at over $1 trillion for some
recent plans over 75 years.5 A variety of approaches can be used to
finance these transition costs, but all involve generating cash revenue to
deposit into the accounts. Some proposals fund the transition costs with
transfers from the general fund of the Treasury, and such transfers are
also known as general revenue transfers. However, these revenues have to
come from somewhere, either from reducing other government spending,
increasing revenues, borrowing from the public, or some combination
thereof.

In the long run, however, the transition costs may be repaid and the net
cost of the accounts to the system might be zero, depending on the design
of the plan. With carve out individual account proposals, workers choosing
to participate in the accounts have their benefits reduced to reflect the
value of the contributions made to their accounts. These benefit offsets
could be a mechanism to pay back the transition costs eventually, but that
cost recovery comes many years after the outflow required for the
transition.

11. Aren't these transition costs less than the cost of fixing the current
system?

While the previously mentioned transition costs for individual accounts
fully fund the accounts, they do not assure solvency of the existing
system. In addition to those transition costs, a combination of additional
benefit

While this estimate indicates the amount of the transition costs over
75-years, it is importantto note that the transition costs may be repaid
and part of this repayment may occur beyond the75-year period. Likewise,
if the repayment begins within the 75-year period, this estimate
mayunderstate the total transition costs.

reductions or revenue increases would still be required to restore 75-year
solvency for the existing system.

12. What effect would individual accounts have on national saving?

The effect that individual accounts have on national saving depends on how
the accounts are financed. Individual account proposals that fund accounts
through redirection of payroll taxes or general revenue do not increase
national saving directly. The redirection of payroll taxes or general
revenue reduces government saving by the same amount that the individual
accounts increase private saving. Individual accounts financed through a
new revenue source, such as increasing payroll taxes, could increase
national saving. Beyond these direct effects, the actual net effect of a
proposal on national saving is difficult to estimate because of
uncertainties in predicting changes in future spending and revenue
policies of the government as well as changes in the saving behavior of
private households and individuals. For example, the higher deficits that
result from redirecting payroll taxes to individual accounts could prompt
changes in fiscal policy that reduce spending or increase revenue thereby
resulting in lower deficits than would otherwise have been the case and
increase net national saving. On the other hand, households may respond by
reducing their other saving in response to the creation of individual
accounts. No expert consensus exists on how Social Security reform
proposals would affect the saving behavior of private households and
businesses.

13. How would individual accounts affect the adequacy of benefits?

Individual accounts have the potential for a higher rate of return on
contributions than is available in the current system. Along with this
potential higher rate of return comes increased risk. Thus, while
individual accounts by themselves may improve the adequacy of benefits, it
is also possible that individual accounts will worsen the adequacy of
benefits. However, since individual accounts do not achieve solvency on
their own, they are typically packaged with other options that reduce
benefits or increase revenues, and it is these options that achieve
solvency. As stated previously, the role of individual accounts in reform
proposals is generally to offer workers an opportunity to make up for the
benefit reductions or other changes that are included as part of the
entire proposal. Therefore, the overall impact that individual accounts
have on the adequacy of benefits will depend on the structure of the
accounts, the other changes included in the reform proposal, the choices
made by the individual, and the performance of the assets in the account.

14. What effect would individual accounts have on the adequacy of benefits
for the disabled, dependents, and survivors?

The effect on adequacy of benefits for subgroups of beneficiaries will
depend on factors unique to each subgroup, as well as the structure of the
individual accounts. Depending on their design, individual accounts will
have a varying effect on the adequacy of benefits for subgroups of
beneficiaries. Under some proposals, individual accounts are likely to be
a bequeathable asset, which may have a significant effect on the benefits
of dependents and survivors. In most cases, disabled beneficiaries leave
the workforce sooner than retired workers. With fewer years to make
contributions and accrue interest, disabled beneficiaries will likely have
smaller account balances. While disabled beneficiaries will still receive
a monthly disability benefit, some proposals do not allow access to income
from individual accounts until an individual reaches retirement age.

15. What issues would arise in implementing individual accounts?

Regardless of how the individual accounts are structured, how readily the
accounts can be implemented, administered, and explained to the public are
important issues. Implementation issues that would need to be addressed
would include, for example, 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
methods and mechanisms that would be used to pay out benefits upon
retirement. These and other changes will require time and funds for
implementation in order to achieve reasonable administrative costs. As
with any changes to Social Security, individuals may need time to make
adjustments to retirement planning. They may also need time to increase
their knowledge of investments and risk. Implementing a system that
includes individual accounts would also raise a number of issues, such as
those regarding the cost of managing accounts and investments, how to
manage financial flows, and other issues.

16. What would happen to administrative costs with individual accounts?

The cost of administering a system with individual accounts is likely to
be higher than the administrative costs of the current system, and this
cost could reduce the amount of savings accumulated in the accounts.
However, individual accounts would provide greater individual choice in
retirement investments and would carry the potential for a higher rate of
return on contributions than is available in the current system. Choices
regarding account administration and record keeping will affect program
administrative costs. A centralized system would take advantage of
economies of scale, which is to say that the more accounts you manage, the
lower the cost for each; thus it could have lower administrative costs
than a decentralized system, especially considering a number of
individuals may initially have small account balances. Administrative
costs will also be affected by the amount of choice individuals have in
their investments. When a wide range of investment choices is offered,
administrative costs are likely to rise. This is especially true if the
choices include more actively managed investments. These investments are
accompanied by higher management fees because the investment manager
spends more time and money on researching, selecting, buying, and selling
investments. In addition, systems that offer individuals the option to
frequently transfer funds between investments or more choice in payout
options can have higher administrative costs. Permitting individuals to
choose among several withdrawal options could increase administrative
complexity and cost by requiring systems to explain and keep track of the
various choices.

17. What tools and educational efforts would workers need to exercise the
increased choices associated with individual accounts?

Individual accounts would require a major, ongoing educational effort to
help individuals understand the accounts. An essential challenge would be
to help 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. This
challenge is even greater if the individual accounts were voluntary since
individuals would need to make informed participation decisions, as well
as understand the effect of a benefit offset based on participation.
Individuals would also need to be informed enough to make prudent
investment decisions, which would require investor education, especially
if individual accounts were mandatory. For example, individuals would need
information on basic investment principles, the risks associated with
available choices, and the effect of choosing among alternatives offered
for annuitizing or otherwise withdrawing or borrowing accumulations from
the accounts. This would be especially important for individuals who are
unfamiliar with making investment choices.

Glossary of Key Terms

V.

Add-On               Individual accounts that would have no effect on      
                        Social Security benefits, would supplement those      
                        benefits, and would draw contributions from new       
                        revenue streams.                                      
Adequacy             (See Income Adequacy.)                                
Annuity              An insurance product that provides a stream of        
                        payments for a pre-established amount of time in      
                        return for a premium payment-the amount being         
                        converted into any annuity. For example, a life       
                        annuity provides payments for as long as the          
                        annuitant lives. Only insurance companies can         
                        underwrite annuities in the United States. Other      
                        financial intermediaries, such as banks and stock     
                        brokerage firms, may sell annuities issued by         
                        insurance companies.                                  
Average Indexed      The average monthly earnings received over a worker's 
Monthly Earnings     career, adjusted yearly by the change in national     
(AIME)               average earnings. It is the dollar amount used to     
                        calculate Social Security benefits for individuals    
                        who attain age 62 or become disabled (or die) after   
                        1978. To arrive at the AIME, SSA adjusts a person's   
                        actual past earnings using an "average wage index,"   
                        so he or she does not lose the value of past earnings 
                        in relation to more recent earnings. For people who   
                        attained age 62 or became disabled (or died) before   
                        1978, SSA uses Average Monthly Earnings (AME).        
Baby Boomers         Cohort of Americans born from 1946 through 1964; 76   
                        million strong, they represent the longest sustained  
                        population growth in U.S. history.                    
Baseline             A measurement that serves as a basis against which    
                        all following measurements are compared.              
Benchmark            A measurement or standard that serves as a point of   
                        reference by which process performance is measured.   
Carve-Out            Individual accounts that would result in some         
                        reduction or offset to Social Security benefits       
                        because contributions to those accounts would draw on 
                        existing Social Security revenues.                    
Consumer Price Index A measure of the change over time in the prices,      
(CPI)                inclusive of sales and excise taxes, paid by urban    
                        households for a representative market basket of      
                        consumer goods and services. The CPI is prepared by   
                        the U. S. Department of Labor and used to compute     
                        COLA increases.                                       

Contribution and   The cap on taxable earnings used to fund Social         
Benefit Base       Security. The cap, also called the taxable maximum wage 
                      or taxable wage base, limits the earnings that can be   
                      used in the benefit formula and, therefore, limits the  
                      size of benefits. The cap limits the program's costs    
                      and the payroll taxes that pay for them. Limiting the   
                      size of benefits reflects the program's role of only    
                      providing for a floor of protection. In 2005, the cap   
                      is $90,000.                                             
Cost-of-Living     An increase (or decrease) in wages or benefits          
Adjustment (COLA)  according to the rise (or fall) in the cost-of-living   
                      as measured by some statistical measure, often the      
                      Consumer Price Index (CPI). Social Security benefits    
                      and Supplemental Security Income payments are increased 
                      each year to keep pace with increases in the            
                      cost-of-living (inflation), as measured by the CPI.     
Covered Worker     Workers in covered employment, that is, jobs through    
                      which the workers have made contributions to Social     
                      Security.                                               
Debt Held by the   Federal debt held by all investors outside of the       
Public             federal government, including individuals,              
                      corporations, state or local governments, the Federal   
                      Reserve banking system, and foreign governments. When   
                      debt held by the Federal Reserve is excluded, the       
                      remaining amount is referred to as privately held debt. 
Deficit            The amount by which the government's spending exceeds   
                      its revenues in a given period, usually a fiscal year.  
                      The federal deficit is the shortfall created when the   
                      federal government spends more in a fiscal year than it 
                      receives in revenues. To cover the shortfall, the       
                      government sells bonds to the public.                   
Defined Benefit    A type of retirement plan that guarantees a specified   
                      retirement payment at a certain age and after a         
                      specified period of service. Defined benefit plans      
                      promise their participants a steady retirement income,  
                      generally based on years of service, age at retirement, 
                      and salary averaged over some number of years. Defined  
                      benefit plans express benefits as an annuity, but may   
                      offer departing participants the opportunity to receive 
                      lump sum distributions. Defined benefit plans are one   
                      of two basic types of employer-sponsored pension plans. 

Defined Contribution A type of retirement plan that establishes individual 
                        accounts for employees to which the employer,         
                        participants, or both make periodic contributions.    
                        Defined contribution plan benefits are based on       
                        employer and participant contributions to and         
                        investment returns (gains and losses) on the          
                        individual accounts. Employees bear the investment    
                        risk and often control, at least in part, how their   
                        individual account assets are invested. Defined       
                        contribution plans are one of two basic types of      
                        employer-sponsored pension plans.                     
Dependency Ratio     A rough estimate of the number of dependents per      
                        worker; generally defined as the ratio of the elderly 
                        (ages 65 and older) plus the young (under age 15) to  
                        the population in the working ages (ages 15-64).      
Dependent            A person who is eligible for benefits or care because 
                        of his or her relationship to an individual. Under    
                        the Social Security Act, "dependent" means the same   
                        as it does for federal income tax purposes; i.e.,     
                        someone for whom the individual is entitled to take a 
                        deduction on his personal income tax return,          
                        generally an individual supported by a tax filer for  
                        over half of a calendar year.                         
Disabled             Disability under Social Security is based on the      
                        inability to work. SSA considers a person disabled    
                        under Social Security rules if the person cannot do   
                        work that he or she did before and SSA decides that   
                        the person cannot adjust to other work because of his 
                        or her medical condition(s). A person's disability    
                        must also last or be expected to last for at least 1  
                        year or to result in death. Social Security program   
                        rules assume that working families have access to     
                        other resources to provide support during periods of  
                        short-term disabilities, including workers'           
                        compensation, insurance, savings, and investments.    
                        The definition of disability under Social Security is 
                        different than under other programs. Social Security  
                        pays only for total long-term disability. No benefits 
                        are payable for partial disability or for short-term  
                        disability.                                           
Dually Entitled      Workers who qualify for Social Security benefits from 
                        both their own work and their spouses'. Such workers  
                        do not receive both the benefits earned as a worker   
                        and the full spousal benefit; rather, the worker      
                        receives the higher amount of the two.                

Early Retirement Age  The age at which individuals qualify for reduced     
                         retirement benefits if they choose to collect        
                         benefits before the normal retirement age; the       
                         current early retirement age for Social Security is  
                         62. Individuals who choose to take retirement        
                         benefits early will have their monthly benefits      
                         permanently reduced, based on the number of months   
                         they receive checks before they reach full           
                         retirement age.                                      
Eligibility           Conditions that must be met for participation. To be 
                         eligible for Social Security retirement benefits,    
                         everyone born in 1929 or later needs 40 credits.     
                         Since a worker can earn 4 credits per year, he or    
                         she needs at least 10 years of work that is subject  
                         to Social Security to become eligible for Social     
                         Security retirement benefits. Each year, the amount  
                         of earnings needed for a credit rises as the average 
                         earnings levels rise. In 2005, a worker receives 1   
                         credit for each $920 of earnings, up to the maximum  
                         of 4 credits per year.                               
Entitlement           A federal program or provision of law that requires  
                         payments to any person or unit of government that    
                         meets the eligibility criteria established by law.   
                         Social Security, Medicare, Medicaid, and veterans'   
                         compensation are examples of entitlement programs.   
                         Entitlements leave no discretion with Congress on    
                         how much money to appropriate, and some entitlements 
                         carry permanent appropriations.                      
Equity, including     The goal to ensure that the costs and benefits of    
Intergenerational     Social Security bear some relationship to            
                         contributions and that a much greater burden is not  
                         placed on certain specific groups, including certain 
                         generations of workers.                              
Full Retirement Age   (Also called normal retirement age.) The age at      
(FRA)                 which individuals qualify for full, or unreduced,    
                         retirement benefits from Social Security and         
                         employer-sponsored pension plans. The normal         
                         retirement age for Social Security was 65 for many   
                         years. Beginning with year 2000 for workers and      
                         spouses born 1938 or later and widows/ widowers born 
                         1940 or later, the normal retirement age increases   
                         gradually from age 65 until it reaches age 67 in the 
                         year 2022.                                           
Fully Funded          A system that is fully funded, or "advance funded,"  
                         is one in which sufficient contributions are put     
                         aside each year to pay for future benefits when they 
                         come due. Defined contribution pensions and          
                         individual retirement accounts are fully funded by   
                         definition.                                          

General Revenue    Funds moved from the General Fund of the Treasury to    
Transfers          other programs, sometimes to maintain the solvency of   
                      those programs. General funds, constituting about       
                      two-thirds of the budget, have no direct link between   
                      how they are raised and how they are spent. General     
                      fund receipts include income and excise taxes.          
Gross Domestic     A commonly used measure of domestic national income.    
Product (GDP)      GDP measures the market value of total output of final  
                      goods and services produced within a country's          
                      territory, regardless of the ownership of the factors   
                      of production involved, i.e., local or foreign, during  
                      a given time period, usually a year. Earnings from      
                      capital invested abroad (mostly interest and dividend   
                      receipts) are not counted, while earnings on capital    
                      owned by foreigners but located in the country in       
                      question are included. GDP may be expressed in terms of 
                      product-consumption, investment, government purchases   
                      of goods and services, and net exports-or it may be     
                      expressed in terms of income earned-wages, interest,    
                      and profits. It is a rough indicator of the economic    
                      earnings base from which government draws its revenues. 
Hospital Insurance Also referred to as Part A of Medicare. HI provides     
(HI)               inpatient hospital care, skilled nursing care home      
                      health and hospice care subject to a benefit period     
                      deductible, and copayments for certain services.        
Income Adequacy    In Social Security's history, "adequacy" has never been 
                      explicitly defined. However, the Congress expected that 
                      Social Security benefits would eventually provide more  
                      than a "minimal subsistence" in retirement for          
                      full-time, full-career workers. Various measures help   
                      examine different aspects of this concept, but no       
                      single measure can provide a complete picture. Such     
                      measures include poverty rates, replacement rates, and  
                      the proportion of the population that depends on others 
                      for income support.                                     
Indexation         (See Price Indexation, Wage Indexation.)                
Individual Equity  The relationship of benefits to contributions; for      
                      example, implicit rates of return on Social Security    
                      contributions or money's-worth ratios.                  

National Saving     Total saving by all sectors of the economy: personal   
                       saving, business saving (corporate after-tax profits   
                       not paid as dividends), and government saving (the     
                       budget surplus or deficit-indicating dissaving-of all  
                       government entities). National saving represents all   
                       income not consumed, publicly or privately, during a   
                       given period. Net national saving is gross national    
                       saving less consumption of fixed capital               
                       (depreciation).                                        
Off-Budget          Refers to the status of transactions of the government 
                       (either federal funds or trust funds) that belong      
                       on-budget according to generally accepted budget       
                       concepts, but which are required by law to be excluded 
                       from the budget. The budget documents routinely report 
                       the on-budget and off-budget amounts separately and    
                       then add them together to arrive at the consolidated   
                       government totals.                                     
Old-Age, Survivors, The two Social Security programs-Old-Age and Survivors 
and Disability      Insurance (OASI) and Disability Insurance (DI)-that    
Insurance (OASDI)   provide monthly cash benefits to beneficiaries and     
                       their dependents when the beneficiaries retire, to     
                       beneficiaries' surviving dependents, and to disabled   
                       worker beneficiaries and their dependents.             
On-Budget           Refers to transactions that are included within the    
                       budget.                                                
Pay-As-You-Go       System of financing in which contributions that        
                       workers make in a given year fund the payments to      
                       beneficiaries in that same year, and the system's      
                       trust funds are kept to a relatively small contingency 
                       reserve.                                               
Payroll Tax         Tax imposed on some or all of workers' earnings that   
                       can be imposed on employers, employees, or both.       
                       Payroll taxes are used to finance the Social Security  
                       and Medicare programs. Employers and employees each    
                       pay Social Security taxes equal to 6.2 percent of all  
                       employee earnings up to a cap and pay Medicare taxes   
                       of 1.45 percent, with no cap. Payroll taxes are also   
                       known as FICA (Federal Insurance Contributions Act)    
                       taxes or SECA (Self-Employment Contributions Act), if  
                       self-employed.                                         

Poverty           Americans are considered "poor" or "in poverty" if they  
                     reside in a household with income below the U.S. poverty 
                     threshold, as defined by the U.S. Office of Management   
                     and Budget. Poverty thresholds differ by family size and 
                     are updated annually for inflation using the Consumer    
                     Price Index. Median Social Security benefits have        
                     historically been close to the poverty threshold. Social 
                     Security has contributed to reducing poverty among the   
                     elderly.                                                 
Price Indexation  (Compare Wage Indexation.) A method by which benefits    
                     are adjusted at periodic intervals by a factor derived   
                     from an index of prices; one prominent Social Security   
                     reform proposal would price-index earnings to compute    
                     benefits, instead of using wage indexing. Over time,     
                     increases in wages have been greater and are expected to 
                     continue to be greater than increases in prices.         
                     Indexing earnings to prices instead of wages would       
                     therefore reduce the average lifetime earnings used in   
                     the formula, which, in turn, would reduce benefits.      
Primary Insurance The monthly amount payable to a retired or disabled      
Amount (PIA)      worker; it is based on a worker's average indexed        
                     monthly earnings.                                        
Progressive       Adjusted so that the rate increases as the amount        
                     increases. Describes a tax in which the rich pay a       
                     larger fraction of their income than the poor. To help   
                     ensure that beneficiaries have adequate incomes, Social  
                     Security's benefit formula is designed to be             
                     progressive, that is, to provide disproportionately      
                     larger benefits, as a percentage of earnings, to lower   
                     earners than to higher earners.                          
Rate of Return    The gain or loss generated from an investment over a     
                     specified period of time; also referred to as total      
                     return. Calculated as the (value now minus value at time 
                     of purchase) divided by value at time of purchase,       
                     expressed as a percentage. In the context of Social      
                     Security, the implicit rate of return on Social Security 
                     contributions would be the constant discount rate that   
                     equates the present discounted value of contributions    
                     with the present discounted value of benefits.           
Replacement Rate  The ratio of retirement benefits (from Social Security   
                     or employer-sponsored plans) to pre-retirement earnings. 
                     Analysts often compare current benefits to a recipient's 
                     previous wages to judge the adequacy of Social Security  
                     payments. In the context of Social Security, the         
                     implicit rate of return on Social Security contributions 
                     would be the constant discount rate that equates the     
                     present discounted value of contributions with the       
                     present discounted value of benefits.                    

Social Insurance       Under a social insurance program, the society as a  
                          whole insures its members against various risks     
                          they all face, and members pay for that insurance   
                          at least in part through contributions to the       
                          system. Social insurance programs, including Social 
                          Security, are designed to achieve certain social    
                          goals.                                              
Social Security        The federal agency that administers all Social      
Administration (SSA)   Security-related programs, including the            
                          Supplemental Security Income (SSI) and the          
                          Disability Insurance (DI) programs.                 
Solvency               For Social Security, a condition of financial       
                          viability in which the program can meet its full    
                          financial obligations as they come due.             
                          Specifically, the ability to pay full benefits      
                          using existing revenue sources and trust fund       
                          balances. When a program does not meet these        
                          conditions, it is said to be insolvent.             
Solvency, Sustainable  For Social Security, to achieve sustainable         
                          solvency is to maintain the program's solvency      
                          beyond Social Security's Board of Trustees' 75-year 
                          forecast and make Social Security permanently       
                          solvent. Also defined as having a stable and        
                          growing trust fund ratio with program revenues      
                          increasing faster than outlays at the end of the    
                          75-year period.                                     
Supplemental Security  A federal supplemental income program funded by     
Income (SSI)           general tax revenues (not Social Security taxes)    
                          that helps aged, blind, and disabled people who     
                          have little or no income, by providing monthly cash 
                          payments to meet basic needs for food, clothing,    
                          and shelter.                                        
Supplementary Medical  Medicare SMI, also referred as Part B, is a         
Insurance (SMI)        voluntary insurance program that covers physician   
                          services (in or outside of the hospital),           
                          outpatient hospital services, ambulatory services,  
                          and certain medical supplies and other services,    
                          for all persons age 65 or older and persons         
                          eligible for Part A because of disability or        
                          chronic renal disease.                              

Survivor (Survivor After a beneficiary's death, Social Security survivor   
Benefits)          benefits are paid to the beneficiary's survivors, which 
                      include                                                 
                      o  the beneficiary's widow/widower age 60 or older, 50  
                      or older if disabled, or any age if caring for a child  
                      under age 16 or who became disabled                     
                      before age 22;                                          
                      o  the beneficiary's children, if they are unmarried    
                      and under age 18, under 19 but still in school, or 18   
                      or older but disabled before age 22;                    
                      o  the beneficiary's parents if the beneficiary         
                      provided at least one-half of their support.            
                      A special one-time lump sum payment of $255 may be made 
                      to a spouse or minor children. An ex-spouse could also  
                      be eligible for a widow/widower's benefit on the        
                      beneficiary's record.                                   
Taxable Maximum    (See Contribution and Benefit Base.)                    
Wage               
Taxable Wage Base  (See Contribution and Benefit Base.)                    
Transition Costs   Refers to the additional revenue required to implement  
                      substitute individual account plans. Under some         
                      individual account plans, portions of Social Security   
                      contributions                                           
                      would be diverted to the accounts. However, under       
                      Social Security's pay-as-you-go financing, some of      
                      those contributions would also be needed to pay for     
                      current                                                 
                      benefits. Making account deposits while also meeting    
                      current benefit costs requires additional revenue,      
                      which we refer to as transition costs.                  
Trust Fund         An account, designated as a "trust fund" by law, that   
                      is credited with income from earmarked collections and  
                      charged with certain outlays. Collections may come from 
                      the public (for example, from taxes or user charges) or 
                      from intrabudgetary transfers. The federal government   
                      has more than 150 trust funds. The largest and          
                      best-known finance major benefit programs (including    
                      Social Security and Medicare) and infrastructure        
                      spending (the Highway and the Airport and Airway Trust  
                      Funds). These trust funds are essentially sub-accounts  
                      of the federal government's accounting and budgeting    
                      processes.                                              

  Unified Budget

The present form of the budget of the federal government in which receipts
and outlays from federal funds and trust funds are consolidated into a
single total. The unified budget includes trust fund receipts as income
and trust fund payments as expenditures. As a result, any Social Security
surpluses serve to reduce the overall, or unified, federal budget deficit.

  Wage Indexation

(Compare Price Indexation.) A method by which benefits are adjusted at
periodic intervals. Under its current formula, SSA uses the national
average wage indexing series to index a person's lifetime earnings when
computing that person's Social Security benefits.

Social Security Reform: Early Action Would Be Prudent. GAO-05-397T.
Washington, D.C.: Mar. 9, 2005.

Social Security: Distribution of Benefits and Taxes Relative to Earnings
Level. GAO-04-747. Washington, D.C.: June 15, 2004.

Social Security Reform: Analysis of a Trust Fund Exhaustion Scenario.

GAO-03-907. Washington, D.C.: July 29, 2003.

Social Security: Issues Relating to Noncoverage of Public Employees.

GAO-03-710T. Washington, D.C.: May 1, 2003.

Social Security and Minorities: Earnings, Disability Incidence, and
Mortality Are Key Factors That Influence Taxes Paid and Benefits Received.
GAO-03-387. Washington, D.C.: Apr. 23, 2003.

Social Security Reform: Analysis of Reform Models Developed by the
President's Commission to Strengthen Social Security. GAO-03-310.
Washington, D.C.: Jan. 15, 2003.

Social Security Reform: Information on Using a Voluntary Approach to
Individual Accounts. GAO-03-309. Washington, D.C.: Mar. 10, 2003.

Social Security: Program's Role in Helping Ensure Income Adequacy.

GAO-02-62. Washington, D.C.: Nov. 30, 2001.

Social Security Reform: Potential Effects on SSA's Disability Programs and
Beneficiaries. GAO-01-35. Washington, D.C.: Jan. 24, 2001.

Social Security Reform: Information on the Archer-Shaw Proposal.

GAO/AIMD/HEHS-00-56. Washington, D.C.: Jan. 18, 2000. Social Security:
Evaluating Reform Proposals. GAO/AIMD/HEHS-00-

29. Washington, D.C.: Nov.4, 1999.

Social Security Reform: Implications of Raising the Retirement Age.

GAO/HEHS-99-112. Washington, D.C.: Aug. 27, 1999.

Social Security: Issues in Comparing Rates of Return with Market
Investments. GAO/HEHS-99-110. Washington, D.C.: Aug. 5, 1999.

Social Security: Criteria for Evaluating Social Security Reform Proposals.
GAO/T-HEHS-99-94. Washington, D.C.: Mar. 25, 1999.

Social Security: Implications of Extending Mandatory Coverage to State and
Local Employees. GAO/HEHS-98-196. Washington, D.C.: Aug. 18, 1998.

Social Security: Different Approaches for Addressing Program Solvency.

GAO/HEHS-98-33. Washington, D.C.: 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.
Washington, D.C.: Apr. 22, 1998.

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

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