Social Security: Long-Term Challenges Warrant Early Action	 
(03-FEB-05, GAO-05-303T).					 
                                                                 
Social Security is the foundation of the nation's retirement	 
income system, helping to protect the vast majority of American  
workers and their families from poverty in old age. However, it  
is much more than a retirement program and also provides millions
of Americans with disability insurance and survivors' benefits.  
Over the long term, as the baby boom generation retires and as	 
Americans continue to live longer and have fewer children, Social
Security's financing shortfall presents a major program solvency 
and sustainability challenge that is growing as time passes. The 
Chairman and Ranking Member of the Senate Special Committee on	 
Aging asked GAO to discuss the future of the Social Security	 
program. This testimony will address the nature of Social	 
Security's long-term financing problem and why it is preferable  
for Congress to take action sooner rather than later, as well as 
the broader context in which reform proposals should be 	 
considered.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-303T					        
    ACCNO:   A16836						        
  TITLE:     Social Security: Long-Term Challenges Warrant Early      
Action								 
     DATE:   02/03/2005 
  SUBJECT:   Federal social security programs			 
	     Future budget projections				 
	     Income maintenance programs			 
	     Program evaluation 				 
	     Program management 				 
	     Social security benefits				 
	     Trust funds					 
	     Medicaid program					 
	     Medicare program					 
	     Old-Age and Survivors Insurance Program		 
	     Social Security Program				 
	     SSA Disability Insurance Program			 

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GAO-05-303T

United States Government Accountability Office

GAO Testimony

Before the Special Committee on Aging,

U.S. Senate

For Release on Delivery Expected at 2:00 p.m. EST

Thursday, February 3, 2005 SOCIAL SECURITY

                   Long-Term Challenges Warrant Early Action

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

GAO-05-303T

February 3, 2005

SOCIAL SECURITY

Long-Term Challenges Warrant Early Action

[IMG]

  What GAO Found

Although the Social Security system in not in crisis today, it faces
serious and growing solvency and sustainability challenges. Furthermore,
Social Security's problems are a subset of our nation's overall fiscal
challenge. Absent reform, the nation will ultimately have to choose among
escalating federal deficits and debt, huge tax increases and/or dramatic
budget cuts. GAO's long-term budget simulations show that to move into the
future with no changes in federal retirement and health programs is to
envision a very different role for the federal government. With regard to
Social Security, if we did nothing until 2042, achieving actuarial balance
would require a reduction in benefits of 30 percent or an increase in
payroll taxes of 43 percent. In contrast, taking action soon will serve to
reduce the amount of change needed to ensure that Social Security is
solvent, sustainable, and secure for current and future generations.
Acting sooner will also serve to improve the federal government's
credibility with the markets and the confidence of the American people in
the government's ability to address long-range challenges before they
reach crisis proportions.

However, financial stability should not be the only consideration when
evaluating reform proposals. Other important objectives, such as balancing
the adequacy and equity of the benefits structure need to be considered.
Furthermore, any changes to Social Security should be considered in the
context of the broader challenges facing our nation, such as the changing
nature of the private pension system, escalating health care costs, and
the need to reform Medicare and Medicaid.

Size of Action Needed to Achieve Social Security Solvency

Percentage 50

                                       43

40 30 20 10

0 2004-2078 2018-2078 2042-2078

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

Note: This is based on the intermediate assumptions of the 2004 Social
Security trustees' report. The benefit adjustments in this graph represent
a one-time, permanent change to all existing and future benefits beginning
in the first year indicated. Estimates cover the time period from January
1st of the first year to December 31, 2078.

                 United States Government Accountability Office

Mr. Chairman and Members of the Committee:

Thank you for inviting me here to talk about our nation's Social Security
program and how to address the challenges presented in ensuring the
long-term viability of this important social insurance system. Social
Security not only represents the foundation of our retirement income
system, it also provides millions of Americans with disability insurance
and survivors' benefits. As a result, Social Security provides benefits
that are critical to the current and future well-being of tens of millions
of Americans. As I have said in congressional testimonies over the past
several years, the system faces both solvency and sustainability
challenges in the longer term. While the Social Security program does not
face an immediate crisis, it does have a $3.7 trillion gap between
promised and funded benefits in current dollar terms. This gap is growing
rapidly and, given this and other major fiscal challenges, it would be
prudent to act sooner rather than later to reform the Social Security
program. Failure to take steps to address our large and structural
long-range fiscal imbalance, which is driven in large part by projected
increases in Medicare, Medicaid and Social Security spending, will
ultimately have significant adverse consequences for our future economy
and quality of life.

Let me begin by highlighting a number of important points concerning the
Social Security challenge.

o  	Solving Social Security's long-term financing problem is more
important and complex than simply making the numbers add up. Social
Security is an important and successful social insurance program that
affects virtually every American family. It currently pays benefits to
more than 47 million people, including retired workers, disabled workers,
the spouses and children of retired and disabled workers, and the
survivors of deceased workers. The number of individuals receiving
benefits is expected to grow to almost 69 million by 2020. The program has
been highly effective at reducing the incidence of poverty among the
elderly, and the disability and survivor benefits have been critical to
the financial well-being of millions of others.

o  	Focusing on trust fund solvency alone is not sufficient. We need to
put the program on a path toward sustainable solvency. Trust fund solvency
is an important concept, but focusing on trust fund solvency alone can
lead to a false sense of security about the overall financial condition of
the Social Security program. For example, the size of the trust fund does
not tell us whether the program is

sustainable-that is, whether the government will have the capacity to pay
future claims or what else will have to be squeezed to pay those claims.
Furthermore, estimates of what it would take to achieve 75-year trust fund
solvency understate the extent of the problem because the program's
financial imbalance gets worse in the 76th and subsequent years.

o  	Social Security reform is part of a broader fiscal and economic
challenge. If you look ahead in the federal budget, the combined Social
Security or Old-Age and Survivors Insurance and Disability Insurance
(OASDI) program, together with the rapidly growing health programs, will
dominate the federal government's future fiscal outlook. While this
hearing is not about the complexities of Medicare, it is important to note
that Medicare presents a much greater, more complex, and more urgent
fiscal challenge than does Social Security. Medicare growth rates reflect
not only a burgeoning beneficiary population, but also the escalation of
health care costs at rates well exceeding general rates of inflation.
Taken together, Social Security, Medicare, and Medicaid represent an
unsustainable burden on future generations. Under the 2004 Trustees'
intermediate estimates and the Congressional Budget Office's (CBO)
long-term Medicaid estimates, spending for Social Security, Medicare, and
Medicaid combined will grow to 15.6 percent of GDP in 2030 from today's
8.5 percent. Absent meaningful changes to these programs, the nation will
ultimately have to choose among persistent, escalating federal deficits,
huge tax increases, and/or dramatic budget cuts. Furthermore, any changes
to Social Security should be considered in the context of the problems
currently facing our nation's private pension system. These include the
chronically low level of coverage of the private workforce, the continued
decline in defined benefit plans coupled with the termination of large
underfunded plans by bankrupt firms, and the shift by employers to defined
contribution plans, where workers face the potential for greater return
but also assume greater financial risk.

o  	Acting sooner rather than later helps to ease the difficulty of
change. As I noted previously, the challenge of facing the imminent and
daunting budget pressure from Medicare, Medicaid, and OASDI increases over
time. Social Security will begin to constrain the budget long before the
trust fund is exhausted in 2042. The trust fund cash surpluses that are
now helping to finance the rest of the government's budgetary needs will
begin to decline after 2008, and by 2018, the cash surpluses will turn
into deficits. At that point, Social Security's cash shortfall will begin
to place increasing pressure on the rest of the budget to raise the
resources necessary to meet the program's costs.

Waiting until Social Security faces an immediate solvency crisis will
limit the scope of feasible solutions and could reduce the options to only
those choices that are the most difficult. It could also contribute to a
further delay of the really tough decisions on Medicare and Medicaid.
Acting sooner rather than later would allow changes to be phased in so
that future and near-term retirees have time to adjust their retirement
planning. Furthermore, acting sooner rather than later would serve to
increase our credibility with the markets and improve the public's
confidence in the federal government's ability to deal with our
significant long-range fiscal challenges before they reach crisis
proportions.

o  	Reform proposals should be evaluated as packages. The elements of any
package interact; every package will have pluses and minuses, and no plan
will satisfy everyone on all dimensions. If we focus on the pros and cons
of each element of reform by itself, we may find it impossible to build
the bridges necessary to achieve consensus. It is also important to
establish the appropriate comparisons or benchmarks against which reforms
should be measured. Given the current projected financial shortfall of the
program, it is important to compare proposals to at least two
benchmarks-one that raises revenue to fund currently scheduled benefits
(promised benefits) and one that adjusts to current tax financing by
reducing benefits (funded benefits). Comparing the benefit impact of
reform proposals solely to currently scheduled Social Security benefits is
inappropriate since all current scheduled benefits are not funded over the
longer term. Estimating future effects on Social Security benefits should
reflect the fact that the program faces a long-term actuarial deficit and
that benefit reduction and/or revenue increases will be necessary to
restore solvency. The key point is that there is a significant gap between
scheduled benefits and projected revenues. In fact, a primary purpose of
most Social Security reform proposals is to close or eliminate this gap.

Failure to address the Social Security financing problem will, in
combination with other entitlement spending, constitute an unsustainable
burden on both the federal government and, ultimately, the economy.
However, this problem is about more than finances. It is also about
maintaining an adequate safety net for American workers against loss of
income from retirement, disability, or death. Social Security has
prevented many former workers and their families from living their
retirement years in poverty. As the Congress considers proposals to
restore the long-term financial stability and viability of the Social
Security system, it will also need to consider the impact of the potential
changes on the millions of

  Social Security's Long-term Financing Problem Is More Urgent than It May
  Appear

Americans the system serves: specifically, the effects on different types
of beneficiaries and the resulting implications for the adequacy and
equity of the benefits structure. The fundamental nature of the program's
long-term financing challenge means that timely action is needed. I
believe it is possible to craft a solution that will protect Social
Security benefits for the nation's current and near-term retirees, while
ensuring that the system will be solvent, sustainable, and secure for
future generations. Stated differently, I believe that it is possible to
reform Social Security in a way that will ensure the program's solvency,
sustainability, and security while exceeding the expectations of all
generations of Americans. I also believe that, given our other fiscal
challenges, it is prudent to act sooner rather than later to address this
large and growing problem.

Today, the Social Security program does not face an immediate crisis, but
it does face a long-range financing problem driven primarily by known
demographic trends that is growing rapidly. While the crisis is not
immediate, the challenge is more urgent than it may appear. Acting soon to
address these problems reduces the likelihood that the Congress will have
to choose between imposing severe benefit cuts and unfairly burdening
future generations with the program's rising costs. Acting soon would also
allow changes to be phased in so that the individuals who are most likely
to be affected, namely younger and future workers, will have time to
adjust their retirement planning while helping to avoid related
"expectation gaps." On the other hand, failure to take remedial action
will, in combination with other entitlement spending, lead to a situation
unsustainable for both the federal government and, ultimately, the
economy.

The Social Security system has required changes in the past to ensure
future solvency. Indeed, the Congress has always taken the actions
necessary to do this when faced with an immediate solvency crisis. I would
like to spend some time describing the nature, timing, and extent of
Social Security's financing problem.

The Causes of Social As you all know, Social Security has always been a
largely pay-as-you-go Security's Long-Term system. This means that the
system's financial condition is directly Financing Problem affected by the
relative size of the populations of covered workers and

beneficiaries. Historically, this relationship has been favorable. Now,

however, people are living longer, and spending more time in retirement.
As shown in figure 1, the U.S. elderly dependency ratio is expected to
continue to increase.1 The proportion of the elderly population relative
to the working-age population in the U.S. rose from 13 percent in 1950 to
19 percent in 2000. By 2050, there is projected to be almost 1 elderly
dependent for every 3 people of working age-a ratio of 32 percent.
Additionally, the average life expectancy of males at birth has increased
from 66.6 in 1960 to 74.3 in 2000, with females at birth experiencing a
rise of 6.6 years from 73.1 to 79.7 over the same period. As general life
expectancy has increased in the United States, there has also been an
increase in the number of years spent in retirement. Improvements in life
expectancy have extended the average amount of time spent by workers in
retirement from 11.5 years in 1950 to 18 years for the average male worker
as of 2003. A falling fertility rate is the other principal factor
underlying the growth in the elderly's share of the population. In the
1960s, the fertility rate was an average of 3 children per woman.2 Today
it is a little over 2, and by 2030 it is expected to fall to 1.95-a rate
that is below what it takes to maintain a stable population. Taken
together, these trends threaten the financial solvency and sustainability
of this important program.

1The elderly dependency ratio is the ratio of the population aged 65 years
or over to the population aged 15 to 64.

2The fertility rate is the average number of children a hypothetical
cohort of women would have at the end of their reproductive period if they
were subject during their whole lives to the fertility rates of a given
period and if they were not subject to mortality. It is expressed as
children per woman.

Figure 1: U.S. Elderly Dependency Ratio Expected to Continue to Increase

Elderly dependency ratio (in percent)

35

30

25

20

15

10

5

0 1950 1980 2000 2030 2050

Source: Population Division of the Department of Economic and Social
Affairs of the United Nations Secretariat, World Population Prospects:
2002 Revision and World Urbanization Prospects: 2001 Revision. Data for
2030 - 2050 are projected.

The result of these trends is that labor force growth will continue to
decline in 2006 and by 2025 is expected to be less than a fifth of what it
is today, as shown in figure 2. Relatively fewer U.S. workers will be
available to produce goods and services. Without a major increase in
productivity or increases in immigration, low labor force growth will lead
to slower growth in the economy and to slower growth of federal revenues.
This in turn will only accentuate the overall pressure on the federal
budget.

Figure 2: U.S. Labor Force Growth Will Continue to Decline

Percentage change (5-year moving average)

3

2

1

0 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

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

Note: Percentage change is calculated as a centered 5-year moving average
of projections based on the intermediate assumptions of the 2004 Trustees
Reports.

This slowing labor force growth has important implications for the Social
Security system. Social Security's retirement eligibility dates are often
the subject of discussion and debate and can have a direct effect on both
labor force growth and the condition of the Social Security retirement
program. It is also appropriate to consider whether and how changes in
pension and/or other government policies could encourage longer workforce
participation. To the extent that people choose to work longer as they
live longer, the increase in the amount of time spent in retirement could
be diminished. This could improve the finances of Social Security and
mitigate the expected slowdown in labor force growth.

The Social Security program's situation is one symptom of this larger
demographic trend that will have broad and profound effects on our
nation's future in other ways as well. The aging of the labor force and
the reduced growth in the number of workers will have important
implications for the size and composition of the labor force, as well as
the characteristics of many jobs in our increasingly knowledge-based
economy, throughout the 21st century. The U.S. workforce of the 21st
century will be facing very different opportunities and challenges than
those of previous generations.

Cash Flow Turns Negative in 2018

Today, the Social Security Trust Funds take in more in taxes than they
spend. Largely because of the demographic trends I have described, this
situation will change. Although the trustees' 2004 intermediate estimates
project that the combined Social Security Trust Funds will be solvent
until 2042, program spending will constitute a rapidly growing share of
the budget and the economy well before that date. Under the trustees' 2004
intermediate estimates, Social Security's cash surplus-the difference
between program tax income and the costs of paying scheduled benefits-
will begin to decline in 2008. By 2018, the program's cash flow is
projected to turn negative-its tax income will fall below benefit
payments. At that time, the program will begin to experience a negative
cash flow, which will accelerate over time. Social Security will join
Medicare's Hospital Insurance Trust Fund, whose outlays exceeded cash
income in 2004, as a net claimant on the rest of the federal budget. (See
figure 3.)

Figure 3: Social Security and Medicare's Hospital Insurance Trust Funds
Face Cash Deficits

Billions of 2004 dollars 250 125 0 -125 -250 -375 -500 -625 -750

Social Security cash deficit 2018

2000 2005 2010 2015 2020 2025 2030 2035

                           Social Security cash flow

                             Medicare HI cash flow

Source: GAO analysis based on the intermediate assumptions of The 2004
Annual Report of the Board of Trustees of the Federal Old-Age and
Survivors Insurance and the Federal Disability Insurance Trust Funds and
The 2004 Annual Report of the Boards of Trustees of the Federal Hospital
Insurance and Federal Supplementary Medical Insurance Trust Funds. The
above excludes Medicare Part B and the newly enacted Medicare Part D
benefit.

In 2018, the combined OASDI Trust Funds will begin drawing on its Treasury
securities to cover the cash shortfall. At this point, Treasury will need
to obtain cash for these redeemed securities either through increased
taxes, spending cuts, and/or more borrowing from the public than would
have been the case had Social Security's cash flow remained positive.
Whatever the means of financing, the shift from positive to negative cash
flow will place increased pressure on the federal budget to raise the
resources necessary to meet the program's ongoing costs.

Different Measures but There are different ways to describe the magnitude
of the problem. A case Same Challenges and Same can be made for a range of
different measures, as well as different time Conclusion horizons. For
instance, the actuarial deficit can be measured in present

value, as a percentage of GDP, or as a percentage of taxable payroll in
the future. The Social Security Administration (SSA) and CBO have both
made projections of Social Security's future actuarial deficit using
different horizons. (See table 1.)

 Table 1: Different Measures, Same Challenge Projection horizon Projections of
                         actuarial deficit in terms of

                                              Present  Percent     Percent of 
                                                value   of GDP        payroll 
                      75 year (SSA)   $3.7 Trillion      0.7%           1.89% 
                     100 year (CBO)   $4.6 Trillion     0.54%           1.44% 
             Infinite horizon (SSA)  $10.4 Trillion      1.2%            3.5% 

Sources: Social Security Administration, The 2004 Annual Report of the
Board of Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds. Washington, D.C., March 2004.
Congressional Budget Office, The Outlook for Social Security: Potential
Range of Social Security Outlays and Revenues Under Current Law.
Washington, D.C., June 2004.

CBO uses a 100-year horizon to project Social Security's future actuarial
deficit, while the Social Security Administration utilizes both 75-year
and infinite horizon projections to estimate the future deficit. In
addition, both the Social Security Administration and CBO have different
economic assumptions for variables such as real earnings, real interest
rates, inflation, and unemployment.

While their estimates vary due to different horizons and economic
assumptions, each identifies the same long-term challenge: The Social
Security system is unsustainable in its present form over the long run.
Taking action soon on Social Security would not only make the necessary
action less dramatic than if we wait but would also promote increased
budgetary flexibility in the future and stronger economic growth. Some of
the benefits of early action-and the costs of delay-can be seen in figure

4. This figure compares what it would take to keep Social Security solvent
through 2078, if action were taken at three different points in time, by
either raising payroll taxes or reducing benefits. If we did nothing until
2042-the year SSA estimates the Trust Funds will be exhausted- achieving
actuarial balance would require changes in benefits of 30 percent or
changes in taxes of 43 percent. As figure 4 shows, earlier action shrinks
the size of the necessary adjustment.

      Figure 4: Size of Action Needed to Achieve Social Security Solvency

Percentage 50

                                       45

                                       43

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

Changes in the composition of federal spending over the past several
decades have reduced budgetary flexibility, and our current fiscal path
will reduce it even further. During this time, spending on mandatory
programs has consumed an ever-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. By 2004, this share had almost doubled
to approximately 61 percent of the budget.

                                       40

                                       35

                                       30

                                       25

                                       20

                                       15

                                      10 5

                                       0

2004-2078 2018-2078 2042-2078

Benefit adjustment

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

Note: This is based on the intermediate assumptions of the 2004 Social
Security trustees' report. The benefit adjustments in this graph represent
a one-time, permanent change to all existing and future benefits beginning
in the first year indicated.

Social Security Reform Is Part of a Broader Fiscal and Economic Challenge

If you look ahead in the federal budget, the Social Security programs
(Old-Age and Survivors Insurance and Disability Insurance), together with
the rapidly growing health programs (Medicare and Medicaid), will dominate
the federal government's future fiscal outlook. Absent reform, the nation
will ultimately have to choose among persistent, escalating federal
deficits and debt, huge tax increases and/or dramatic budget cuts. GAO's
long-term budget simulations show that to move into the future with no
changes in federal retirement and health programs is to envision a very
different role for the federal government. Assuming that discretionary
spending grows with inflation and all existing tax cuts are allowed to
expire when scheduled under current law, spending for Social Security and
health care programs would grow to consume over three-quarters of federal
revenue by 2040. Moreover, if all expiring tax provisions are extended and
discretionary spending keeps pace with the economy, by 2040 total federal
revenues may be adequate to pay little more than interest on the federal
debt. (See figure 5.)

Figure 5: Composition of Spending as a Share of GDP

Percent of GDP

50

45

40

35

30

25

20

15

10

5

0 2003 2015 2030 2040 Fiscal year

Revenue

All other spending

Medicare and Medicaid

Social Security

Net interest

Source: GAO's September 2004 analysis.

Notes: Although expiring tax provisions are extended, revenue as a share
of GDP increases through 2014 due to (1) real bracket creep, (2) more
taxpayers becoming subject to the AMT, and (3) increased revenue from
tax-deferred retirement accounts. After 2014, revenue as a share of GDP is
held constant.

Alternatively, taking action soon on Social Security would not only
promote increased budgetary flexibility in the future and stronger
economic growth but would also make the necessary action less dramatic
than if we wait. Indeed, long-term budget flexibility is about more than
Social Security and Medicare. While these programs dominate the longterm
outlook, they are not the only federal programs or activities that bind
the future. The federal government undertakes a wide range of programs,
responsibilities, and activities that obligate it to future spending or
create an expectation for spending. GAO has described the range and
measurement of such fiscal exposures-from explicit liabilities such as

environmental cleanup requirements to the more implicit obligations
presented by life-cycle costs of capital acquisition or disaster
assistance.3 Making government fit the challenges of the future will
require not only dealing with the drivers- entitlements for the
elderly-but also looking at the range of federal activities. A fundamental
review of what the federal government does and how it does it will be
needed.

Also, at the same time it is important to look beyond the federal budget
to the economy as a whole. Under the 2004 Trustees' intermediate estimates
and CBO's long-term Medicaid estimates, spending for Social Security,
Medicare, and Medicaid combined will grow to 15.6 percent of GDP in 2030
from today's 8.5 percent (See figure 6.) Taken together, Social Security,
Medicare, and Medicaid represent an unsustainable burden on future
generations.

3GAO, Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs
and Uncertainties, GAO-03-213 (Washington, D.C.: Jan 24, 2003).

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

Percent of GDP

30

25

20

15

10

5

0 2000 2010 2020 2030 2040 2050 2060 2070 2080

                                    Medicare

                                    Medicaid

                                Social Security

Source: GAO analysis based on data from the Office of the Chief Actuary,
Social Security Administration, Office of the Actuary, Centers for
Medicare and Medicaid Services, and the Congressional Budget Office.

Note: Social Security and Medicare projections based on the intermediate
assumptions of the 2004 Trustees' Reports. Medicaid projected based on
CBO's January 2004 short-term Medicaid estimates and CBO's December 2003
long-term Medicaid projections under mid-range assumptions.

As important as financial stability may be for Social Security, it cannot
be the only consideration. As a former public trustee of Social Security
and Medicare, I am well aware of the central role these programs play in
the lives of millions of Americans. Social Security remains the foundation
of the nation's retirement system. It is also much more than just a
retirement program; it pays benefits to disabled workers and their
dependents, spouses and children of retired workers, and survivors of
deceased workers. In 2004, Social Security paid almost $493 billion in
benefits to more than 47 million people. Since its inception, the program
has successfully reduced poverty among the elderly. In 1959, 35 percent of
the elderly were poor. In 2000, about 8 percent of beneficiaries aged 65
or older were poor, and 48 percent would have been poor without Social
Security. It is precisely because the program is so deeply woven into the
fabric of our nation that any proposed reform must consider the program in
its entirety, rather than one aspect alone. Thus, GAO has developed a

  Considerations in Assessing Reform Options

broad framework for evaluating reform proposals that considers not only
solvency but other aspects of the program as well.

The GAO Criteria for Reform

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

o  	Financing Sustainable Solvency-the extent to which a proposal achieves
sustainable solvency and how it would affect the economy and the federal
budget. Our sustainable solvency standard encompasses several different
ways of looking at the Social Security program's financing needs. While a
75-year actuarial balance has generally been used in evaluating the
long-term financial outlook of the Social Security program and reform
proposals, it is not sufficient in gauging the program's solvency after
the 75th year. For example, under the trustees' intermediate assumptions,
each year the 75-year actuarial period changes, and a year with a surplus
is replaced by a new 75th year that has a significant deficit. As a
result, changes made to restore trust fund solvency only for the 75-year
period can result in future actuarial imbalances almost immediately.
Reform plans that lead to sustainable solvency would be those that
consider the broader issues of fiscal sustainability and affordability
over the long term. Specifically, a standard of sustainable solvency also
involves looking at (1) the balance between program income and costs
beyond the 75th year and (2) the share of the budget and economy consumed
by Social Security spending.

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

program and should still be taken into account in any proposed reforms.

o  	Implementing and Administering Proposed Reforms-how readily a proposal
could be implemented, administered, and explained to the public. Program
complexity makes implementation and administration both more difficult and
harder to explain to the public. Some degree of implementation and
administrative complexity arises in virtually all proposed changes to
Social Security, even those that make incremental changes in the already
existing structure. Although these issues may appear technical or routine
on the surface, they are important issues because they have the potential
to delay-if not derail-reform if they are not considered early enough for
planning purposes. Moreover, issues such as feasibility and cost can, and
should, influence policy choices. Continued public acceptance of and
confidence in the Social Security program require that any reforms and
their implications for benefits be well understood. This means that the
American people must understand why change is necessary, what the reforms
are, why they are needed, how they are to be implemented and administered,
and how they will affect their own retirement income. All reform proposals
will require some additional outreach to the public so that future
beneficiaries can adjust their retirement planning accordingly. The more
transparent the implementation and administration of reform, and the more
carefully such reform is phased in, the more likely it will be understood
and accepted by the American people.

The weight that different policy makers may place on different criteria
will vary, depending on how they value different attributes. For example,
if offering individual choice and control is less important than
maintaining replacement rates for low-income workers, then a reform
proposal emphasizing adequacy considerations might be preferred. As they
fashion a comprehensive proposal, however, policy makers will ultimately
have to balance the relative importance they place on each of these
criteria. As we have noted in the past before this committee and
elsewhere, a comprehensive evaluation is needed that considers a range of
effects together. Focusing on comprehensive packages of reforms will
enable us to foster credibility and acceptance. This will help us avoid
getting mired in the details and losing sight of important interactive
effects. It will help build the bridges necessary to achieve consensus.

One issue that often arises within the Social Security debate concerns the
appropriate comparisons or benchmarks to be used when assessing a
particular proposal. While this issue may seem to be somewhat abstract, it
has critical implications, for depending on the comparisons chosen, a

proposal can be made more or less attractive. Some analyses compare
proposals to a single benchmark and as a result can lead to incomplete or
misleading conclusions. For that reason, GAO has used several benchmarks
in assessing reform proposals.4 Currently promised benefits are not fully
financed, and so any analysis that seeks to fairly evaluate reform
proposals should rely on benchmarks that reflect a policy of an adequately
financed system. Similarly, it is important to have benchmarks that are
consistent with each other. Using one that relies on action relatively
soon versus one that posits no action at all are not consistent and could
also lead to misleading conclusions. Estimating future effects on Social
Security benefits should reflect the fact that the program faces a
long-term actuarial deficit and that conscious policies of benefit
reduction and/or revenue increases will be necessary to restore solvency
and sustain it over time.

Reform Will Have Pervasive Impact on the Social Security Program

A variety of proposals have been offered to address Social Security's
financial problems. Many proposals contain reforms that would alter
benefits or revenues within the structure of the current defined benefits
system. Some would reduce benefits by modifying the benefit formula (such
as increasing the number of years used to calculate benefits or using
price-indexing instead of wage-indexing), reduce cost-of-living
adjustments (COLA), raise the normal and/or early retirement ages, or
revise dependent benefits. Some of the proposals also include measures or
benefit changes that seek to strengthen progressivity (e.g., replacement
rates) in an effort to mitigate the effect on low-income workers. Others
have proposed revenue increases, including raising the payroll tax or
expanding the Social Security taxable wage base that finances the system;
increasing the taxation of benefits; or covering those few remaining
workers not currently required to participate in Social Security, such as
older state and local government employees.

A number of proposals also seek to restructure the program through the
creation of individual accounts. Under a system of individual accounts,
workers would manage a portion of their own Social Security contributions
to varying degrees. This would expose workers to a greater degree of risk
in return for both greater individual choice in retirement investments and
the possibility of a higher rate of return on contributions

4GAO, 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).

than available under current law. There are many different ways that an
individual account system could be set up. For example, contributions to
individual accounts could be mandatory or they could be voluntary.
Proposals also differ in the manner in which accounts would be financed,
the extent of choice and flexibility concerning investment options, the
way in which benefits are paid out, and the way the accounts would
interact with the existing Social Security program-individual accounts
could serve either as an addition to or as a replacement for part of the
current benefit structure.

In addition, the timing and impact of individual accounts on the solvency,
sustainability, adequacy, equity, net savings, and rate of return
associated with the Social Security system varies depending on the
structure of the total reform package. Individual accounts by themselves
will not lead the system to sustainable solvency. Achieving sustainable
solvency requires more revenue, lower benefits, or both. Furthermore,
incorporating a system of individual accounts may involve significant
transition costs. These costs come about because the Social Security
system would have to continue paying out benefits to current and near-term
retirees concurrently with establishing new individual accounts.

Individual accounts can contribute to sustainability as they could provide
a mechanism to prefund retirement benefits that would be immune to
demographic booms and busts. However, if such accounts are funded through
borrowing, no such prefunding is achieved. An additional important
consideration in adopting a reform package that contains individual
accounts would be the level of benefit adequacy achieved by the reform. To
the extent that benefits are not adequate, it may result in the government
eventually providing additional revenues to make up the difference.

Also, some degree of implementation and administrative complexity arises
in virtually all proposed changes to Social Security. The greatest
potential implementation and administrative challenges are associated with
proposals that would create individual accounts. These include, for
example, issues concerning the management of the information and money
flow needed to maintain such a system, the degree of choice and
flexibility individuals would have over investment options and access to
their accounts, investment education and transitional efforts, and the
mechanisms that would be used to pay out benefits upon retirement. The
Federal Thrift Savings Plan (TSP) could serve as a model for providing a
limited amount of options that reduce risk and administrative costs while
still providing some degree of choice. However, a system of accounts that

spans the entire national workforce and millions of employers would be
significantly larger and more complex than the TSP or any other system we
have in place today.

Harmonizing a system that includes individual accounts with the regulatory
framework that governs our nation's private pension system would also be a
complicated endeavor. However, the complexity of meshing these systems
should be weighed against the potential benefits of extending
participation in individual accounts to millions of workers who currently
lack private pension coverage.

Social Security Reform Should Be Considered in the Context of Broader
Challenges

Another important consideration for Social Security reform is assessing a
proposal's effect on national saving. Individual account proposals that
fund accounts through redirection of payroll taxes or general revenue do
not increase national saving on a first order basis. The redirection of
payroll taxes or general revenue reduces government saving by the same
amount that the individual accounts increase private saving. Beyond these
first order effects, the actual net effect of a proposal on national
saving is difficult to estimate due to 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 lower surpluses and higher deficits that result from
redirecting payroll taxes to individual accounts could lead to changes in
federal fiscal policy that would increase 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.

Finally, the effort to reform Social Security is occurring as our nation's
private pension system is also facing serious challenges. Only about half
of the private sector workforce is covered by a pension plan. A number of
large underfunded traditional defined benefit plans-plans where the
employer bears the risk of investment-have been terminated by bankrupt
firms, including household names like Bethlehem Steel, US Airways, and
Polaroid. These terminations have resulted in thousands of workers losing
promised benefits and have saddled the Pension Benefit Guaranty
Corporation, the government corporation that partially insures certain
defined benefit pension benefits, with billions of dollars in liabilities
that threaten its long-term solvency. Meanwhile, the number of traditional
defined benefit pension plans continues to decline as employers
increasingly offer workers defined contribution plans like 401(k) plans

where, like individual accounts, workers face the potential of both
greater return and greater risk. These challenges serve to reinforce the
imperative to place Social Security on a sound financial footing.

Regardless of what type of Social Security reform package is adopted,
continued confidence in the Social Security program is essential. This
means that the American people must understand why change is necessary,
what the reforms are, why they are needed, how they are to be implemented
and administered, and how they will affect their own retirement income.
All reform proposals will require some additional outreach to the public
so that future beneficiaries can adjust their retirement planning
accordingly. The more transparent the implementation and administration of
reform, and the more carefully such reform is phased in, the more likely
it will be understood and accepted by the American people.

Conclusions 	Social Security does not face an immediate crisis but it does
face a large and growing financial problem. In addition, our Social
Security challenge is only part of a much broader challenge that includes,
among other things, the need to reform Medicare, Medicaid and our overall
health care system.

Today many retirees and near retirees fear cuts that would affect them in
the immediate future while young people believe they will get little or no
Social Security benefits in the longer term. I believe that it is possible
to reform Social Security in a way that will ensure the program's
solvency, sustainability, and security while exceeding the expectations of
all generations of Americans.

In my view, there is a window of opportunity to reform Social Security;
however, this window of opportunity will begin to close as the baby boom
generation begins to retire. Furthermore, it would be prudent to move
forward to address Social Security now because we have much larger
challenges confronting us that will take years to resolve. The fact is,
compared to addressing our long-range health care financing problem,
reforming Social Security should be easy lifting.

We at GAO look forward to continuing to work with this Committee and the
Congress in addressing this and other important issues facing our nation.
In doing so, we will be true to our core values of accountability,
integrity, and reliability.

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