Social Security and Surpluses: GAO's Perspective on the President's
Proposals (Testimony, 02/23/99, GAO/T-AIMD/HEHS-99-96).

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 net 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 trading publicly held debt for debt held
by the Social Security Trust Fund (SSTF) 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; (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-99-96
     TITLE:  Social Security and Surpluses: GAO's Perspective on the
	     President's Proposals
      DATE:  02/23/99
   SUBJECT:  Economic analysis
	     Presidential proposals
	     Deficit reduction
	     Stocks (securities)
	     Federal social security programs
	     Budget surplus
	     Debt held by public
	     Fiscal policies
	     Financial management
IDENTIFIER:  Social Security Trust Fund
	     Social Security Program

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GAO

United States General Accounting OfficeTestimony

Before the Committee on Ways and Means, House of Representatives

For Release on Delivery Expected at 3 p.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-99-96 

Page 1 GAO/T-AIMD/HEHS-99-96

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.

Page 2 GAO/T-AIMD/HEHS-99-96

This perspective is particularly important because our model and
that of 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

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.

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.

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-99-96

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 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

Page 4 GAO/T-AIMD/HEHS-99-96

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  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

Page 5 GAO/T-AIMD/HEHS-99-96

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-99-96

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.

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-99-96

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  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.

FICA  Surplus Special  Treasuries

Transfer forTrust 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 ofequities

Other Taxes Benefits

Unified Budget FICA Taxes

Page 8 GAO/T-AIMD/HEHS-99-96

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  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.  At any given interest rate,
reducing publicly held debt reduces net interest payments within
the

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

Page 9 GAO/T-AIMD/HEHS-99-96

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  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 the  Senate Budget
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-99-96

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-99-96 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. 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--   -14   (,0)   0.003   --nostringval--   -14
(,5)   0.003   --nostringval--   -14   (,0)   0.003   --
nostringval--   -14   (,5)   0.003   --nostringval--   -14   (,0)
0.003   --nostringval--   -14   (,5)   0.003   --nostringval--   -
14   (,0)   0.003   --nostringval--   -14   (,5)   0.003   --
nostringval--   -14   (,0)   0.003   --nostringval--   -14   (,5)
0.003   --nostringval--   -14   (,0)   0.003   --nostringval--
40   0   -14   -14   (ent)   -14   -40   -200   40   -14   (et)
-200   40   0   -14   -200   40   -14   (al)   -200   53   -14   -
14   (i)   -14   0   -200   40   -14   (pos)   0.003   --
nostringval--   40   0   -14   53   -14   -14   (t)   -200   40
-14   (nce)   --nostringval--   40   53   -160   53   -14   (eli)
0.003   --nostringval-- Execution stack: %interp_exit   ()   --
nostringval--   --nostringval--   --nostringval--   false   --
nostringval--   --nostringval--   14   1   31   --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

*** End of document. ***