Social Security and Surpluses: GAO's Perspective on the President's
Proposals (Testimony, 02/23/99, GAO/T-AIMD/HEHS-99-95).

Pursuant to a congressional request, GAO discussed the President's
proposal for addressing social security and use of the budget surplus.

GAO noted that: (1) the President's proposal: (a) reduces debt held by
the public from current levels, thereby also reducing new interest
costs, raising national saving, and contributing to future economic
growth; (b) fundamentally changes social security financing by promising
general funds in the future by, in effect, trading publicly held debt
for debt held by the Social Security Trust Fund and by investing some of
the trust fund in equities with the goal of capturing higher returns
over the long term; (c) does not have any effect on the projected cash
flow imbalance in the social security program's taxes and benefits which
begins in 2013; and (d) does not represent a social security reform plan
and does not come close to saving social security; (2) budget surpluses
provide a valuable opportunity to capture significant long-term gains to
both improve the nation's capacity to address the looming fiscal
challenges arising from demographic change and aid in the transition to
a more sustainable social security program; (3) the President's proposal
may prompt a discussion and decision on both how much of the current
resources the nation wants to save for the future and how it can best do
so; (4) a substantial share of the surpluses would be used to reduce
publicly held debt, providing demonstrable gains for the nation's
economic capacity to afford future commitments; (5) in this way, the
proposal would help the nation, in effect, prefund these commitments by
using today's wealth earned by current workers to enhance the resources
for the next generations; (6) the transfer of surplus resources to the
trust fund, which the administration argues is necessary to lock in
surpluses for the future, would nonetheless constitute a major shift in
financing for the social security program, but it would not constitute
real social security reform because it does not modify the program's
underlying commitments for the future; (7) moreover, the proposed
transfer may very well make it more difficult for the public to
understand and support the savings goals articulated; (8) several other
nations have shown how debt reduction itself can be made to be publicly
compelling, but only Congress can decide whether such an approach will
work in the United States; (9) GAO is very concerned that enhancing the
financial condition of the trust fund alone without any comprehensive
and substantive program reforms may in fact undermine the fundamental
changes; and (10) explicitly pledging federal general revenues to social
security will limit the options for dealing with other national issues.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD/HEHS-99-95
     TITLE:  Social Security and Surpluses: GAO's Perspective on the
	     President's Proposals
      DATE:  02/23/99
   SUBJECT:  Federal social security programs
	     Economic analysis
	     Presidential proposals
	     Deficit reduction
	     Stocks (securities)
	     Fiscal policies
	     Debt held by public
	     Financial management
	     Trust funds
	     Budget surplus
IDENTIFIER:  Social Security Program
	     Social Security Trust Fund

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GAO

United States General Accounting OfficeTestimony

Before the Committee on the Budget, U.S. Senate

For Release on Delivery Expected at 9:30 a.m. Tuesday, February
23, 1999 

SOCIAL SECURITY AND SURPLUSES

GAO's Perspective on the President's  Proposals Statement of David
M. WalkerComptroller General of the United States

GAO/T-AIMD/HEHS-99-95

 Page 1 GAO/T-AIMD/HEHS-99-95

Mr. Chairman and Members of the Committee:  It is a pleasure to be
here today to discuss the President's recent proposal for
addressing Social Security and use of the budget surplus.  These
proposals address some of the most important issues facing the
nation, both now and over the longer term.  As you know, both GAO
as an  institution and I as an individual have a long-standing
interest in these issues.

The President's proposal is complex, which makes it all the more
important for us to focus our attention on what it does--and what
it does not do--for  our long-term future.  In summary, the
President's proposal:

* Reduces debt held by the public from current levels, thereby
also reducing net interest costs, raising national saving, and
contributing to

future economic growth.* Fundamentally changes Social Security
financing in two ways:

* It promises general funds in the future by, in effect, trading
publicly held debt for debt held by the Social Security Trust Fund
(SSTF).

* It invests some of the trust fund in equities with the goal of
capturing higher returns over the long term.

* Does not have any effect on the projected cash flow imbalance in
the Social Security program's taxes and benefits, which begins in
2013.

* Does not represent a Social Security reform plan and does not
come close to "saving Social Security."

Context:  Long-Term Outlook Is Important It is important to look
at the President's proposal in the context of the fiscal situation
in which we find ourselves.  After nearly 30 years of unified

budget deficits, we look ahead to projections for "surpluses as
far as the eye can see."  At the same time, we know that we face a
demographic

tsunami in the future that poses significant challenges for the
Social Security system, Medicare, and our economy as a whole.  In
this context,  we should recognize that the President uses a
longer-term framework for resource allocation than has been
customary in federal budgeting.

Although all projections are uncertain--and they get more
uncertain the farther out they go--we have long held that a long-
term perspective is  important in formulating fiscal policy for
the nation.  Each generation is in part the custodian for the
economy it hands the next and the nation's longterm economic
future depends in large part on today's budget decisions.  This
perspective is particularly important because our model and that
of

Page 2 GAO/T-AIMD/HEHS-99-95

the Congressional Budget Office (CBO) continue to show that absent
a change in policy, the changing demographics to which I referred
above will  lead to renewed deficits.  This longer-term problem
provides the critical backdrop for making decisions about today's
surpluses.

Surpluses are the result of a good economy and difficult policy
decisions.  They also provide a unique opportunity to put our
nation on a more  sustainable path for the long term, both for
fiscal policy and the Social Security program itself.  Current
decisions can help in several important  respects: (1) current
fiscal policy decisions can help expand the future capacity of our
economy by increasing national savings and investment,  (2)
engaging in substantive reforms of retirement and health programs
can reduce future claims,  (3) by acting now, we have the
opportunity of  phasing in changes to Social Security and health
programs over a sufficient period of time to enable our citizens
to adjust, and (4) failure to achieve  needed reforms in the
Social Security and Medicare programs will drive future spending
to unsustainable levels and eventually "squeeze out" most  or all
discretionary spending.  If we let the achievement of a budget
surplus lull us into complacency about the budget, then in the
middle of the  21st century, we could face daunting demographic
challenges without having built the economic capacity or
program/policy reforms to handle  them.

The Proposal Before turning to the context for and analysis of the
President's proposal, let me briefly describe it.  The President
proposes to use approximately

two-thirds of the total projected unified budget surpluses over
the next 15 years to reduce debt held by the public and to address
Social Security's

financing problem.  His approach to this, however, is extremely
complex and confusing.  The President proposes to "transfer" an
amount equal to a  portion of the projected surplus to the Social
Security and Medicare trust funds.1   This transfer is projected
to extend the solvency of Social Security  from 2032 to 2049.  His
proposal to permit the trust fund to invest in equities is
expected to further extend trust fund solvency to 2055.  He calls
on the Congress to work with him on program changes to get to
2075.

1In this testimony, I will address only the Social Security
portion of this transfer.  The issues are similar  but not
identical for the Medicare trust fund transfer.

Page 3 GAO/T-AIMD/HEHS-99-95

To understand and evaluate this proposal, it is important to
understand the nature of the federal budget, how trust funds fit
into that budget, and the  challenges of "saving" within the
federal budget.

Can We Save for the Future in the Federal Budget? The federal
budget is a vehicle for making choices about the allocation of
scarce resources.  It is different from state budgets in ways
important to

this discussion.  Most states use "fund budgeting" in which
pension funds that are separate and distinct legal entities, build
up surpluses that are  routinely invested in assets outside the
government (e.g., readily marketable securities held in separate
funds).  In contrast, the federal  government's unified budget
shows all governmental transactions and all funds are available
for current activities, including current-year activities of  all
trust funds.  We cannot park our surplus in a cookie jar.  The
only way to save in the federal budget is to run a surplus or
purchase a financial asset.   When there is a cash surplus it is
used to reduce debt held by the public.  Therefore, to the extent
that there is an actual cash surplus, debt held by  the public
falls. This presents a problem for any attempt to "advance fund"
all or part of future Social Security benefits.  Advance funding
within the current  program would mean increasing the flows to the
SSTF.  Although it is officially "off budget," the fact remains
that the SSTF is a governmental  fund.  In the federal budget,
trust funds are not like private trust funds.  They are simply
budget accounts used to record receipts and expenditures
earmarked for specific purposes.  A private trust fund can set
aside money for the future by increasing its assets.  However,
under current law, when  the SSTF's receipts exceed costs, they
are invested in Treasury securities and used to meet current cash
needs of the government.  These securities  are an asset to the
trust fund, but they are a claim on the Treasury.  Any increase in
assets to the SSTF is an equal increase in claims on the
Treasury.  One government fund is lending to another.  The
transactions net out on the government's books.  Given this
investment policy, any increase  in the trust fund balances would
only become an increase in saving if this increment were to add to
the unified budget surplus (or decrease the  unified budget
deficit) and thereby reduce the debt held by the public.   This is
also the only way in which an increase in the SSTF balance could
be  a form of advance funding. How do these transactions affect
the government's debt?  Gross federal debt is the sum of debt held
by the public and debt held by governmental  accounts--largely
trust funds.  This means that increases in the trust fund

Page 4 GAO/T-AIMD/HEHS-99-95

surplus will increase gross debt unless debt held by the public
declines by at least the same amount. Any reform of Social
Security that increases the  annual SSTF surplus would increase
debt held by government accounts since, under current law, any
excess of revenues over benefit payments is  loaned to Treasury
for current needs.  As a result, total government debt would go up
unless these surpluses were used to reduce debt held by the
public by an equivalent amount. For most people, the different
types of "debt" in the federal budget may be confusing--especially
since what is "good news" for a trust fund may be  "bad news" for
total debt and vice versa.  This is so because total debt (or
gross debt) is the sum of two very different types of debt--debt
owed to the  public and debt owed by one part of the government
(general fund) to another part of the government (trust funds).
Therefore, if a trust fund  surplus grows faster than debt held by
the public falls, total debt grows--even if the trust fund surplus
is created as an attempt to "save" or to  "prefund" some of the
future benefit payments.  These contradictory movements emphasize
the need to differentiate between different types of  debt and
what they mean.  Both debt held by the public and debt held by
trust funds are important--but for different reasons.
Analytically, therefore,  what is most important is not whether
total debt increases but rather the reasons behind the increase--
does it represent an attempt to "advance  fund" through
substantive reform or merely the promise of future resources?

Debt held by the public and debt held by trust funds represent
very different concepts.  Debt held by the public approximates the
federal  government's competition with other sectors in the credit
markets.  This affects interest rates and private capital
accumulation.  Further, interest on  debt held by the public is a
current burden on taxpayers.  Reducing this burden frees up
capacity to meet future needs.

In contrast, debt held by trust funds performs an accounting
function and currently represents the cumulative annual surpluses
of these funds (i.e.,  excess of receipts over disbursements plus
accrued interest).  Importantly, debt held by the SSTF does not
represent the actuarial present value of  expected future benefits
for either current or future participants.  Nor does this debt
have any of the economic effects of borrowing from the public.  It
is not a current transaction of the government with the public; it
does not compete with the private sector for available funds in
the credit market.  It  reduces the need to borrow from the public
and so may hold down interest rates.  Unlike debt held by the
public, debt held by trust funds does not

Page 5 GAO/T-AIMD/HEHS-99-95

represent an immediate burden on current taxpayers.  Rather, it is
a claim on future resources.  The surplus is held in Treasury
securities that give the  SSTF a claim on the Treasury equal to
the value of those securities.  When the securities have to be
redeemed, the Treasury must come up with the  cash.  At that time,
taxpayers will see some combination of a lower surplus, lower
spending, higher taxes, and/or greater borrowing from the public.

If borrowing from the public is increased to cover this cash need,
there could be upward pressure on interest rates.  In addition,
because debt held  by the trust fund is not equal to future
benefit payments--it is not a measure of the unfunded liability of
the current system--it cannot be seen as a  measure of this future
burden.  Nevertheless, it provides an important signal of the
existence of this burden.  Whether the debt constitutes a new
economic burden for the future or merely recognizes an existing
one depends on whether these currently promised benefits would be
paid even  in the absence of the securities.

How Does the President's Proposal Work? This information is
important to understand the President's proposal because, in large
part, he proposes a set of transactions that, in effect, trade

debt held by the public for debt held by the SSTF.2  By running a
cash surplus over the next 15 years, debt held by the public
falls.  To "save" this  surplus, the President proposes to
"transfer" it to the trust fund in the form of increased Treasury
securities.  Under his proposal, debt held by the  public falls,
but debt held by the trust funds increases.  Because he shows the
transfer as a subtraction from the surplus--a new budgetary
concept-- he shows no surplus.  As a result, he attempts to save
some of the projected surplus by hiding it.

The mechanics of the proposed transfer of surpluses to the SSTF
are complex and difficult to follow.  Few details have been made
available, and  there is conflicting information on exactly how it
would work.  Figures 1 and 2 are flowcharts representing our best
understanding of the Social  Security portion of this transfer.
Since it is impossible to understand the changes proposed by the
President without understanding the present  system, figure 1
shows the flows under the current system.  Under current law,
annual cash flow surpluses (largely attributable to excess payroll
taxes  over benefits payments and program expenses) are invested
in Treasury

2Paying down publicly held debt and issuing new special securities
to the SSTF are two different  transactions.  Nevertheless, the
effect is as if the securities are exchanged.

Page 6 GAO/T-AIMD/HEHS-99-95

securities.3  This excess "cash" is commingled with other revenues
and used to finance other governmental activities.  In this way,
SSTF surpluses  have helped and continue to help finance the rest
of the government.  This year, the SSTF surplus is expected to
exceed the general fund deficit so  there is also a surplus in the
unified budget.  Over the entire 15-year period, more than half of
the projected unified surplus is composed of Social  Security
surpluses.  Absent any change in policy, these unified surpluses
will be used to reduce the debt held by the public.

Figure 1:  Current Social Security Flows

*Unified surplus = FICA surplus + general fund surplus Source: GAO
Analysis.

Under the President's proposal, this would continue.  However, as
shown in figure 2, at the point where total tax receipts are
allocated to pay for

3This presentation is somewhat simplified.  In reality, FICA taxes
are collected with income and  corporate taxes by the Treasury and
then allocated by the Treasury to Social Security, Medicare, or
the general fund.  In addition, a portion of income taxes paid on
Social Security benefits flow into the SSTF.

The expenditure side of the SSTF transactions is also simplified
since administrative expenses also flow from the trust fund.
These elements are unchanged by the President's proposal and do
not change  the flows critical to understanding it.

Unified Budget

FICA  Surplus Special  Treasuries

FICA Taxes

*Unified surplus would pay down the debt held

by the public

Social Security

Trust Fund General Fund

Discretionary

Spending

Mandatory

Spending

Other Taxes Benefits

Page 7 GAO/T-AIMD/HEHS-99-95

government activities, a new financing step would be added to
"transfer" a portion of the unified budget surpluses to the Social
Security and Medicare  trust funds.  The unified budget would do
this by providing a new set of securities for these trust funds.
However, the excess cash would still be  used to reduce the debt
held by the public.

Figure 2:  Social Security Flows Under President's Proposal

Source: GAO Analysis. In essence, this exchanges debt held by the
public for debt held by the trust funds.  While there are many
benefits to reducing publicly held debt, it is  important to
recognize that under the current law baseline--i.e., with no
changes in tax or spending policy--this would happen without
crediting  additional securities to the trust funds.  The
administration has defended this approach as a way of assuring
both a reduction in debt held by the public and giving Social
Security first claim  on what they call the "debt-reduction
dividend" to pay future benefits. However, issuing these
additional securities to the SSTF is a discretionary act with
major legal and economic consequences for the future.  Some

FICA  Surplus Special  Treasuries

Transfer for

Trust Fund

Special treasuries and

authority to purchase

equities Unified surplus would pay downthe debt held by the public

Social Security

Trust Fund General Fund

Discretionary

Spending

Mandatory

Spending

Purchase of

equities

Other Taxes Benefits

Unified Budget FICA Taxes

Page 8 GAO/T-AIMD/HEHS-99-95

could view this as double counting--or double-crediting.
Importantly, to the extent it appears that way to the public, it
could undermine confidence  in a system that is already difficult
to explain.  However, the debate over double counting focuses on
the form of the proposal rather than its  substance.  Although
form is important when it interferes with our ability to
understand the substance--and I think this proposal falls into
that  trap--the important debate must be on the substance of the
proposal. This proposal represents a fundamental shift in the way
the Social Security program is financed.  It moves it away from
payroll financing toward a  formal commitment of future general
fund resources for the program.  This is unprecedented.  Later in
my statement, I will discuss the implications of  this proposal
for overall fiscal policy and for the Social Security program.

Government Financing and Debt The President's proposals would have
the effect of reducing debt held by the public from the current
level of 44 percent of Gross Domestic Product

(GDP) to 7 percent over the 15-year period.  The President notes
that this would be the lowest level since 1917.  Nearly two-thirds
of the projected

unified budget surplus would be used to reduce debt held by the
public.  Because the surplus is also to be used for other
governmental activities, the  amount of debt reduction achieved
would be less than the baseline (i.e., a situation in which none
of the surplus was used), but nonetheless the  outcome would
confer significant benefits to the budget and the economy.  Our
previous work on the long-term effects of federal fiscal policy
has shown the substantial benefits of debt reduction.4  One is
lowering the  burden of interest payments in the budget.  Today,
net interest represents the third-largest "program" in the budget,
after Social Security and Defense.  Interest payments, of course,
are a function of both the amount of debt on which interest is
charged and the interest rate. Thus, at any given interest  rate,
reducing publicly held debt reduces net interest payments within
the budget.  For example, CBO estimates that the difference
between spending  the surplus and saving the surplus is $123
billion in annual interest payments by 2009--or almost $500
billion cumulatively between now and  then.  Compared to spending
the entire surplus, the President's proposal would also
substantially reduce projected interest payments.  Lower  interest
payments lead to larger surpluses; these in turn lead to lower
debt

4Budget Issues: Analysis of Long-Term Fiscal Outlook
(GAO/AIMD/OCE-98-19, October 22, 1997).

Page 9 GAO/T-AIMD/HEHS-99-95

which leads to lower interest payments and so on: the miracle of
compound interest produces a "virtuous circle."  The result would
be to  provide increased budgetary flexibility for future
decisionmakers who will be faced with enormous and growing
spending pressures from the aging  population. For the economy,
lowering debt levels increases national saving and frees up
resources for private investment.  This in turn leads to increased
productivity and stronger economic growth over the long term.
Over the last several years, we and CBO have both simulated the
long-term  economic results from various fiscal policy paths.
These projections consistently show that reducing debt held by the
public increases national  income over the next 50 years, thereby
making it easier for the nation to meet future needs and
commitments.  Our latest simulations done for this  committee, as
shown in figure 3, illustrate that any path that saves all or a
significant share of the surplus in the near term would produce
demonstrable gains in per capita GDP over the long run.5  This
higher GDP in turn would increase the nation's economic capacity
to handle all its  commitments in the future.

5The "on-budget balance" path assumes that any surplus in the non-
Social Security part of the budget is  "spent" on either a tax cut
or spending increases or some combination but assumes the current
law path for the Social Security trust fund.  Thus, the surplus in
the Social Security trust fund remains untouched

until it disappears in 2013 after which the unified budget runs a
deficit equal to the SSTF deficit.  The "Save the Surplus" path
assumes no changes in current policies and that budget surpluses
through 2024  are used to reduce debt held by the public.  The "No
Surplus" path assumes that permanent increases in discretionary
spending and tax cuts deplete the surpluses but keep the budget in
balance through 2009.   Thereafter, deficits reemerge as spending
pressures grow.

Page 10 GAO/T-AIMD/HEHS-99-95

Figure 3:  GDP Per Capita Under Alternate Fiscal Policy
Simulations  Source:  GAO Analysis. Under the President's
proposal, debt held by trust funds goes up more rapidly than debt
held by the public falls, largely due to these additional
securities transferred to the trust funds.  Gross debt, therefore,
increases.  It is gross debt--with minor exceptions--that is the
measure that is subject  to the debt limit.  The current limit is
$5.95 trillion.  Under the President's plan, the limit would need
to be raised sometime during 2001.  Under either  the CBO or the
Office of Management and Budget baseline (i.e., save the entire
surplus), the limit would not need to be raised during at least
the  next 10 years. Since other proposals to use the surplus would
also bring forward the time when the debt limit would have to be
raised, the impact of  the President's proposal on debt is in part
a "compared to what?" question.  In figure 4, we show the debt
subject to limit under the baseline, the

25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000 65,000

1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046
2050

On-budget balance Save the surplus No surplus

1998 level

Per capita 1998 dollars

Page 11 GAO/T-AIMD/HEHS-99-95 President's proposal, and a
hypothetical path we have labeled "on-budget balance."6 Figure 4:
Debt Subject to Limit Under Baseline and President's Proposal

Source: OMB, CBO, Senate Budget Committee, and GAO Analysis.
Figures 5 and 6 below compare the composition of debt under the
same three paths: the baseline (save the entire surplus), the
President's proposal  (including both the Social Security proposal
and the other spending), and "on-budget balance."   Figure 5 shows
debt held by the public under all  three scenarios, and figure 6
shows debt held by governmental accounts. As figure 5 shows, debt
held by the public falls under all three scenarios.  Since the
baseline assumes the entire surplus is devoted to reducing debt
held by the public, it shows the greatest drop.  Under the "on-
budget

6The baseline is the CBO baseline.  It assumes that none of the
surplus is used for tax cuts or spending  increases.  "On-budget
balance" assumes that any surplus in the non-Social Security part
of the budget is "spent" on either a tax cut or spending increases
or some combination but that the surplus in the

Social Security trust fund remains untouched.  There is no "on-
budget" surplus until 2001.

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Debt Limit $5,950 Dollars in billions Error: /invalidrestore in --
restore-- Operand stack: --nostringval--   GS1   GS2   GS1   GS1
GS1   GS1   GS1   GS1   GS1   GS1   GS1   GS1   GS1   GS1   GS1
--nostringval--   -17   (,)   0   -17   --nostringval--   -17
(,)   0   -17   --nostringval--   -17   (,)   0   -17   --
nostringval--   -17   (,)   0   -17   --nostringval--   -17   (,)
0   -17   --nostringval--   -17   (,)   0   -17   --nostringval--
-17   (,)   0   -17   --nostringval--   -17   (,)   0   -17   --
nostringval--   -17   (,)   0   -17   --nostringval--   -17   (,)
0   -17   --nostringval--   -17   (,)   0   -17   --nostringval--
51   17   51   (de)   -17   34   (')   -242   51   -17   -17   (t)
-207   51   34   34   -242   51   51   (a)   -17   -190   51   17
(i)   51   (t)   -242   51   34   -17   -17   (s)   -17   --
nostringval--   17   0   17   51   -17   (ge)   -190   51   -17
51   -17   --nostringval--   34   51   -207   34   51   (i)   34
(n)   --nostringval-- Execution stack: %interp_exit   ()   --
nostringval--   --nostringval--   --nostringval--   false   --
nostringval--   --nostringval--   14   1   29   --nostringval--
%for_pos_int_continue   --nostringval--   --nostringval--   --
nostringval-- Dictionary stack: --dict:733/1053--   --dict:0/20--
--dict:51/200--   --dict:51/200--   --dict:112/119--   --
dict:87/100--   --dict:10/10-- Current allocation mode is local

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