Social Security: Criteria for Evaluating Social Security Reform Proposals
(Testimony, 03/25/99, GAO/T-HEHS-99-94).

Social Security forms the foundation for the nation's retirement income
system and, in doing so, provides benefits that are critical to the
well-being of millions of Americans. A wide array of proposals have been
put forth to restore the program's solvency. This testimony provides an
analytical framework for evaluating these proposals. The Comptroller
General discusses the (1) purpose of the Social Security system, (2)
basic criteria for assessing reform proposals, and (3) importance of
establishing the proper benchmarks against which reforms must be
measured. The Comptroller General does not advocate for or against
specific reform proposals or elements. Rather, his remarks are intended
to help clarify the debate over various proposals as Congress continues
to deliberate this important issue. In choosing among proposals,
policymakers need to consider three basic criteria: to what extent a
proposal achieves sustainable solvency and how it would affect the
economy and the federal budget; the balance struck between the twin
goals of individual equity (rates of return on individual contributions)
and income adequacy (level and certainty of benefits); and how readily
these changes could be implemented, administered, and explained to the
public. Although the many reform proposals offer a wide range of
options, all of them would restore long-term solvency through some
combination of benefit cuts, revenue increases, or higher returns from
invested contributions. Making Social Security a sustainable program
involves difficult choices. At the same time, the strong U.S. economy
offers an historic opportunity to deal with this problem. GAO believes
that is it possible to craft a comprehensive package of reforms that
will protect the benefits of current retirees while striking the right
balance of equity and adequacy for future beneficiaries. Regardless of
which reform proposal is adopted, better public education and
information will be needed so that Americans can adjust their retirement
planning accordingly.

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

 REPORTNUM:  T-HEHS-99-94
     TITLE:  Social Security: Criteria for Evaluating Social Security
	     Reform Proposals
      DATE:  03/25/99
   SUBJECT:  Future budget projections
	     Social security benefits
	     Economic analysis
	     Budget deficit
	     Financial management
	     Federal social security programs
	     Retirement benefits
	     Financial analysis
IDENTIFIER:  Social Security Program
	     OASDI
	     Old Age Survivors and Disability Insurance Program

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Cover
================================================================ COVER

Before the Subcommittee on Social Security, Committee on Ways and
Means, House of Representatives

For Release on Delivery
Expected at 10:00 a.m.
Thursday, March 25, 1999

SOCIAL SECURITY - CRITERIA FOR
EVALUATING SOCIAL SECURITY REFORM
PROPOSALS

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

GAO/T-HEHS-99-94

GAO/HEHS-99-94T

(207045)

Abbreviations
=============================================================== ABBREV

  COLA - test
  OASDI - test

SOCIAL SECURITY:  CRITERIA FOR
EVALUATING SOCIAL SECURITY REFORM
PROPOSALS
============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

Thank you for inviting me here today to continue the ongoing
discussion on how best to ensure the long-term viability of our
nation's Social Security program.\1 According to the OASDI Trustees'
1998 mid-range estimates, the program's cash flow is projected to
turn negative in 2013.  In addition, all of the accumulated Treasury
obligations held by the Trust Funds are projected to be exhausted by
2032.  The financing problems facing Social Security pose significant
policy challenges that should be addressed soon in order to lessen
the need for more dramatic reforms later. 

Social Security forms the foundation for our retirement income system
and, in so doing, provides benefits that are critical to the
well-being of millions of Americans.  A wide array of proposals have
been put forth to restore this program's solvency, and the Congress
will need to determine which proposals best reflect our country's
goals for a retirement income program.  Today, I would like to
provide an analytic framework for assessing these proposals.  I would
like to begin by discussing the purpose of the Social Security
system.  The role that we envision for the program will be vital in
deciding which proposals to adopt.  Next, in response to your
invitation to me to appear at this hearing, I would like to offer
what I believe are the basic criteria for assessing reform proposals. 
I would then like to stress that the Congress needs to compare reform
proposal packages.  If we focus on the pros and cons of each element
of reform, we will get mired in the details and lose sight of
important interactive effects.  It will also be more difficult to
build the bridges necessary to achieve consensus.  Finally, I want to
point out the importance of establishing the proper benchmarks
against which reforms must be measured.  Often reform proposals are
compared to current promised benefits, but this benchmark, while in
some ways valid, has some drawbacks.  Currently promised benefits are
not fully financed, and so it might be necessary to use a benchmark
of a fully financed system to fairly evaluate reform proposals. 

My comments today are based largely on a body of work we have
published as well as on ongoing work for this Committee.  It is not
my intention to take a position for or against any individual reform
proposal or elements.  Rather, my testimony is designed to help
clarify the debate on various proposals to help the Congress move
forward in addressing this important national debate.  In choosing
among proposals, policymakers should consider three basic criteria: 

  -- the extent to which the proposal achieves sustainable solvency
     and how the proposal would affect the economy and the federal
     budget;

  -- the balance struck between the twin goals of individual equity
     (rates of return on individual contributions) and income
     adequacy (level and certainty of benefits); and

  -- how readily such changes could be implemented, administered, and
     explained to the public. 

While there are many reform proposals with a wide range of features
and options, all proposals to restore long-term solvency involve some
combination of cutting benefits, raising revenues, or capturing
increased returns from investing contributions.  We will face many
difficult choices in making Social Security a sustainable program. 
But our strong economy gives us an historic opportunity to address
this problem.  Focusing on comprehensive packages of reforms that
protect the benefits of current retirees while achieving the right
balance of equity and adequacy for future beneficiaries will help us
to foster credibility and acceptance.  This is the best way to meet
our obligations and achieve overarching goal that we all seek--that
is, ensuring the retirement income security of current and future
generations. 

--------------------
\1 Social Security refers here to the Old-Age, Survivors, and
Disability Insurance program, or OASDI. 

   DIFFICULT CHOICES ARE NECESSARY
   TO RESTORE SOCIAL SECURITY'S
   SOLVENCY
---------------------------------------------------------- Chapter 0:1

In the past few years, as attention has focused on Social Security's
future financial situation, a wide array of proposals have been put
forth.  Some reduce benefits, some raise revenues; most propose some
combination to restore financial solvency.  The more traditional
reforms seek to preserve the program's structure, restoring solvency
through adjusting benefit and revenue provisions; others would
restructure the system by allowing workers to fund at least some
portion of their benefits through individual accounts.  Regardless of
structure, many proposals rely on capturing increased returns from
market investments.  In evaluating these proposals, it is important
to understand Social Security's fundamental role in ensuring the
income security of our nation's elderly and the nature, timing, and
extent of the financing problem.\2

--------------------
\2 For a discussion, see Social Security:  Different Approaches for
Addressing Program Solvency (GAO/HEHS-98-33, July 22, 1998). 

      SOCIAL SECURITY IS THE
      FOUNDATION OF OUR NATION'S
      RETIREMENT INCOME SYSTEM
-------------------------------------------------------- Chapter 0:1.1

Social Security has long served as the foundation of our nation's
retirement income system, which has traditionally been comprised of
three parts:  Social Security, employer-sponsored pensions (both
public and private), and personal savings.\3 Social Security provides
a floor of income protection that the voluntary forms of employer
pensions and individual savings can build on to provide a secure
retirement.  However, private pension plans only cover about one-half
of the full-time workforce, and a significant portion of the American
public does not have significant personal savings.  In addition,
Social Security is the sole source of retirement income for almost a
fifth of recipients.  (See fig.  1.)

   Figure 1:  Social Security
   Benefits as a Percentage of
   Income

   (See figure in printed
   edition.)

Given Social Security's importance as the foundation of retirement
income security, it has been a major contributor to the dramatic
reduction in poverty among the elderly population.  Since 1959,
poverty rates for the elderly have fallen from nearly 35 percent to
10.5 percent.  (See fig.  2.)

   Figure 2:  Poverty Rates for
   the Elderly, 1959 to 1996

   (See figure in printed
   edition.)

Social Security's benefit structure represents a retirement income
insurance program whereby workers pool the risks associated with the
loss of earnings due to old age, disability, or death.  It is a
mandatory and almost universal program.  As a result, the vast
majority of American workers take Social Security credits with them
whenever they change jobs.  Social Security also provides
inflation-protected benefits for the life of the retiree.  No matter
how long they live, retirees will continue to receive Social Security
benefits uneroded by inflation.  The program, which provides benefits
not generally available as a package in the private market, includes
benefits for retired workers, their spouses and dependents, and their
survivors as well as for those who are disabled. 

--------------------
\3 For a discussion of this traditional approach to retirement
income, see Retirement Income:  Implications of Demographic Trends
for Social Security and Pension Reform (GAO/HEHS-97-81, July 11,
1997). 

      THE FINANCING PROBLEM NEEDS
      TO BE ADDRESSED NOW
-------------------------------------------------------- Chapter 0:1.2

The Congress has always taken the actions necessary to ensure Social
Security's future solvency when faced with an immediate solvency
crisis.  These actions have generally been adjustments to the benefit
and revenue provisions of the program.  Today, the program does not
face an immediate crisis; rather, it faces a long-range and more
fundamental financing problem due to demographic trends.  While the
crisis is not immediate, it is important to act soon if we are to
avoid having to unfairly burden future generations with the program's
rising costs and give these individuals time to make necessary
adjustments to their retirement planning. 

Social Security's financial condition is directly affected by the
relative size of the populations of covered workers and
beneficiaries.  Historically, this relationship has been favorable,
but a major reason we are debating Social Security's financing today
is that the covered worker-to-retiree ratio and other demographic
factors--in particular, life expectancy--have changed in ways that
threaten the financial solvency and sustainability of this important
national program.  (See fig.  3.)

   Figure 3:  Ratio of Workers to
   Beneficiaries

   (See figure in printed
   edition.)

Thus, while the program was put in 75-year actuarial balance just 15
years ago, Trust Fund balances now are projected to be exhausted in
2032.  In addition, the program will begin to experience a negative
cash flow in 2013, which will accelerate over time.  (See fig.  4.)
Absent meaningful program reform, this will place increased pressure
on the federal budget to raise the resources necessary to meet the
program's ongoing costs.  To restore the 75-year actuarial balance to
the program today, we would need to immediately increase annual
program revenues by 16 percent or reduce annual benefit payments by
14 percent across the board. 

   Figure 4:  Social Security
   Income and Cost Rates

   (See figure in printed
   edition.)

Note:  Includes revenues from income taxation of Social Security
benefits.  By 2075, the amount would be 13.4 percent of payroll. 

Another way to understand the magnitude of the problem is to consider
what the system will cost as a percentage of taxable payroll in the
future.  Consider what would happen if we did nothing and let the
Trust Funds be exhausted in 2032, as estimated in the 1998 Trustees'
report.  It would then be necessary to find resources in the
following year that would be more than 37 percent higher than the
revenues projected to be available under the 12.4 percent payroll tax
that currently finances the system.  (See fig.  5.) Alternatively, we
would have to reduce benefits in the year following Trust Fund
exhaustion by 27 percent.  Clearly, we must act soon in order to
minimize the needed changes and maximize the fairness to future
generations. 

   Figure 5:  Percentage Changes
   Needed to Maintain Solvency

   (See figure in printed
   edition.)

Note:  Percentage changes are necessary to maintain solvency for the
next year only. 

      PROPOSALS RELY ON DIFFERENT
      BENEFIT ADJUSTMENTS AND
      FINANCING ARRANGEMENTS
-------------------------------------------------------- Chapter 0:1.3

A variety of proposals have been offered to address Social Security's
financial problems.  Some would reduce benefits by modifying the
benefit formula (such as increasing the number of years used to
calculate benefits), reducing cost-of-living adjustments (COLA),
raising the normal and/or early retirement ages, or revising
dependent benefits.  Others have proposed revenue increases,
including raising the payroll tax 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 would incorporate investment returns to increase revenues
and to reduce benefit cuts, or tax increases that would otherwise be
required, or both. 

In fact, almost all proposals combine benefit reductions and changes
designed to gain increased investment returns.  The proposals differ
not only with regard to specific benefit changes but also in how
investment returns are captured.  Some would change the Trust Fund's
investment policy so that the government could purchase equities or
other instruments besides Treasury securities; others would
restructure the Social Security system so that participants could
invest at least part of their own contributions.  The latter approach
creates individual accounts as a means to finance and accumulate
future benefits, rather than relying entirely on payroll tax
financing through a centrally managed government trust fund account. 

These proposals also differ in how such increased returns would be
financed.  Some would use a portion of current payroll tax
collections--a "carve-out" from the Trust Fund--while others would
"add-on" federal budget surpluses (that is, general revenues) or
additional payroll taxes as a means to finance either current
benefits or individual accounts.  These choices carry with them
implications for individual beneficiaries, the Social Security
program, the federal budget, and the national economy.  Such
implications should be well understood before a policy choice is
made. 

   CHOOSING AMONG REFORM PROPOSALS
---------------------------------------------------------- Chapter 0:2

Proposals that restore solvency to Social Security necessarily
combine several or even a multitude of changes to the program. 
Although these changes are presented in a comprehensive package,
debate often focuses on individual aspects that, on their own, are
undesirable.  For example, many criticize proposals to raise the
normal retirement age without considering the other, potentially
offsetting elements of the proposals of which this change would be a
part.  Although such criticisms are legitimate and can contribute to
the public debate, it is critically important to evaluate the effects
of an entire package before considering whether these proposed
changes add up to acceptable program reform.  If a comprehensive
package of reforms meets policymakers' most important goals for
Social Security, individual elements of the package may be more
acceptable.  After all, individual reform elements can drive
interactive effects that can tend to smooth the rough edges of the
individual elements.  In addition, it's important to look at a
complete puzzle before rendering final judgments and understand how
it would stand up against relevant reform criteria.  For example,
phasing in an increased normal retirement age coupled with adding
individual accounts could result in more flexibility and benefit
levels for baby boomers and generation Xers compared with the current
system. 

Evaluating such packages can be complex, however.  What factors or
elements should such evaluation measure?  What weight should be
placed upon particular factors?  I would not presume to tell
policymakers which factors or elements should prove decisive for them
in choosing among proposed reform packages.  I am, however, in a
position to suggest what factors to consider in making these choices. 

Over the course of the last several years, various reform proposals
have been crafted with specific goals in mind--articulated in terms
of solvency, the economy, individual equity, and income adequacy. 
Two primary criteria can be used to evaluate these proposals:  (1)
the extent to which they achieve sustainable solvency and their
effect on the economy and the federal budget and (2) the balance they
strike between the twin goals of individual equity and income
adequacy.  I would also add a third criterion, which, although not
addressing a goal of Social Security reform, focuses on the important
practical aspects of reform--that is, how readily such changes could
be implemented, administered, and explained to the public.  These
elements provide a basis to address a range of more detailed
questions (see attachment 1) that help describe and measure the
potential effects of various proposals on important policy and
operational aspects of public concern.  Measuring proposals against
these three criteria can help shed light on the important choices we
face; I will discuss each in turn. 

      CRITERION 1:  FINANCING
      SUSTAINABLE SOLVENCY
-------------------------------------------------------- Chapter 0:2.1

Crafting a sustainable solution to Social Security's financing
problem involves more than ensuring long-range actuarial balance,
although actuarial balance is also a goal to be achieved.  Simply
taking the actions necessary to put the Social Security system back
into an exact 75-year actuarial balance could result in having to
revisit these difficult issues again in the not-too-distant future. 
For example, if we were to raise payroll taxes 2.19 percent--which,
according to the 1998 Trustees' annual report, is the amount
necessary to achieve 75-year balance--the system would be out of
balance almost immediately and the 2013 cash problem I cited earlier
would move forward only to the year 2020. 

Historically, the program's solvency has generally been measured over
a 75-year projection period.  If projected revenues equal projected
outlays over the 75-year time horizon, then the system is declared in
actuarial balance.  Unfortunately, this measure of solvency is highly
transient and involves what could be called a "cliff effect." (See
fig.  6.) 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 solvency only for the
75-year period will result in future actuarial imbalances almost
immediately. 

   Figure 6:  Social Security
   Trust Fund Financial Outlook

   (See figure in printed
   edition.)

Moreover, the problem is not one that is 74 years away because the
program will begin running annual cash deficits long before the trust
funds actually deplete their assets.  Add to this the possibility
that adverse economic or demographic conditions could accelerate the
depletion of the trust funds, and the time when the Congress would
need to address the problem moves even closer.  Therefore, simply
restoring 75-year actuarial balance today could mean that the
Congress would have to visit these issues again in just 15 or 20
years.  In fact, today's debate is a testimony to this fact.  About
16 years ago, the President and the Congress thought they had saved
Social Security for current and future generations.  That reform
package did save us from the brink of bankruptcy, but it did not
address the cliff effect. 

Solutions that lead to sustainable solvency are those that avoid the
need to periodically revisit this difficult issue, but they have
implications for the risk borne by individuals.  To the extent that a
worker's future retirement benefits are funded in advance--in that
they will depend on contributions and the earnings (rates of return)
on those contributions--the system is at less risk of insolvency from
unfavorable demographic or economic trends.  While pre-funding
benefits has obvious advantages with respect to sustainability over
the largely pay-as-you-go system currently in place, individuals bear
more risk under such an approach, and the social insurance aspects of
the program could be weakened. 

Reforms that provide sustainable solvency could also have positive
effects for the economy at large.  To the extent that pre-funding
worker retirement results in increased savings and investment, the
overall future economy would be larger, making it easier for the
nation to support a larger elderly population.  Simply put, if the
dollar that the worker contributes today is invested in private
assets (stocks and bonds), there is a reasonable chance that the
dollar will contribute to a growing economy.  The dollar invested
will grow in value and provide a return to the owner of the asset. 
Thus, investment returns will, in general, help us finance a given
benefit in the future more cheaply (that is, with less expenditure
today) than the way we currently finance Social Security. 

How the measures to achieve solvency are financed can have important
implications for the federal budget and the national economy.  In
addition, federal fiscal policy itself can be an important element in
fostering economic growth.  Our work on the long-term fiscal outlook
shows that replacing deficits with surpluses increases national
income over the next 50 years, thereby making it easier for the
nation to meet future needs and commitments.  Thus, it is important
to consider the interaction of federal fiscal policy with measures to
restore program solvency in laying a foundation for a sustainable
Social Security program.  For example, proposals using budget
surpluses to fund individual accounts, to purchase private stocks or
bonds for the trust fund, or reduce publicly held debt would all have
some positive effects on national saving and economic growth.  Yet,
considerable debate exists over the relative extent of the economic
benefits under these different alternatives.  Using the projected
budget surpluses to reduce publicly held debt alone would indirectly
make the Social Security system more sustainable but would not reform
or restructure the existing program.  I discussed this at greater
length before this Committee several weeks ago in the context of the
President's budget proposals.\4

Furthermore, some proposals must finance what most analysts call
"transition costs," and how these are financed matters as well.  When
proposals incorporate some degree of pre-funding--either via
individual accounts or through the current program structure--current
workers would, in effect, contribute both to their own accounts and
pay for the benefits of current retirees under the existing defined
benefit program.  The resulting incremental transition costs must be
financed.  If transition costs are financed by borrowing or with
projected budget surpluses, the effects on Social Security
participants would be mitigated, but the positive effects of
pre-funding on national saving could be neutralized in the near term
by additional public borrowing. 

Sustainable solvency is an important criterion in assessing reform
proposals but may require trade-offs between short-run and long-run
gains.  Further, it is not the only criterion by which to evaluate
reform proposals.  The economic and financing considerations that
achieve sustainable solvency should be measured against equity and
adequacy concerns as well. 

--------------------
\4 See Social Security and Surpluses:  GAO's Perspective on the
President's Proposals (GAO/T-AIMD/HEHS-99-96, Feb.  23, 1999). 

      CRITERION 2:  BALANCING
      EQUITY AND ADEQUACY IN THE
      BENEFIT STRUCTURE
-------------------------------------------------------- Chapter 0:2.2

The current Social Security system's benefit structure is designed to
address the twin goals of individual equity and retirement income
adequacy.  Individual equity means that there should be some
relationship between contributions made and benefits received (that
is, rates of return on individual contributions).  Retirement income
adequacy is addressed by providing proportionately larger benefits to
lower earners and certain household types, such as those with
dependents (that is, a progressive and targeted benefit structure). 
Virtually all reform proposals address the concept of income
adequacy, but some place a different emphasis on it relative to the
goal of individual equity.  Differences in how various proposals
balance these competing goals will help determine which proposals
will be acceptable to policymakers and the public. 

Policymakers could assess this balance by considering the extent to
which proposals address the following concerns: 

  -- Adequacy:  (1) adequate benefit levels to protect the elderly
     from poverty and (2) higher replacement rates for low-income
     workers. 

  -- Equity:  (1) reasonable returns on contributions, (2) improved
     intergenerational equity, and (3) increased individual choice
     and control. 

The weight individual policymakers may place on different concerns
would 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
reform proposals emphasizing adequacy considerations might be
preferred. 

Each proposal for reform will have an impact on individuals and
families, whether limited to changes within the current program's
structure or whether some portion of the program's financial gap is
to be closed through access to equity markets.  To restore solvency
only via changes to current benefits or current payroll tax revenues
reduces the implicit rate of return that future cohorts of
beneficiaries will receive on their contributions.  (See fig.  7.)
This serves to reduce individual equity and, depending on what exact
measures are taken, could compromise adequacy as well.  To preserve
the existing protections and income adequacy for certain types of
beneficiaries under this approach, it could be necessary to reduce
the benefits of other types of beneficiaries.  To avoid such a
result, payroll taxes (or the maximum taxable ceiling) might be
raised, but this could make current or future workers worse off. 
Adding the prospect of additional earnings to the system, either from
market investment returns or from some other external source, could
boost individual equity while reducing the necessity for other
changes to the program, depending on how the investment returns or
other revenues are shared. 

   Figure 7:  Social Security's
   Implicit Rates of Return

   (See figure in printed
   edition.)

Note:  These estimates do not include all Social Security disability
contributions and benefits.  They do reflect tax rates that would
keep the system in actuarial balance on a pay-as-you-go basis.  They
use the intermediate assumptions of the 1991 Social Security
Trustees' Report. 

In considering this balance, it helps to understand that Social
Security is currently structured as a defined benefit program and
that restructuring this program to include individual accounts would
add, in effect, a defined contribution element to the system.  Under
Social Security, workers' retirement benefits are based on lifetime
records of earnings, not directly on the payroll taxes they
contributed.  Based on the current design of the Social Security
program and known demographic trends, the rate of return most
individuals will receive on their contributions is declining.  In
addition, as noted previously, current promised benefits are not
adequately funded over the 75-year projection period. 

Alternatively, those who propose individual accounts as part of the
financing solution emphasize the potential benefits of a defined
contribution structure as an element of the Social Security program
or financing reform.  This approach to Social Security focuses on
directly linking a portion of worker contributions to the retirement
benefits that will be received.  Worker contributions are invested in
financial assets and earn market returns; the accumulations in these
accounts can then be used to provide income in retirement.  Under
this approach, individual workers have more control over the account
and more choice in how the account is invested.  This control might
enable individuals to earn a higher rate of return on their
contributions than under current law.  But, of course, these
opportunities for higher returns exist because the investor assumes
some measure of risk that the return expected may not actually be
realized. 

Some reform proposals incorporating individual accounts address the
need for protecting individuals and ensuring income adequacy by
combining the defined contribution and defined benefit approaches
into a two-tiered structure for Social Security.  Under such a
structure, individuals would receive a base defined-benefit amount
with a progressive benefit formula and a supplemental
defined-contribution account benefit.  The benefit that would be
earned through individual account accumulations would either be added
to a restructured defined benefit amount (that is, supplement) or
subtracted, in whole or in part, from the benefits that would
otherwise be provided through Social Security's defined benefit
structure (that is, offset).  Either approach could require
redesigning the benefit structure to ensure the types of protections
currently provided by Social Security.  Such a structure could
include a modified version of the current defined benefit program or
could incorporate various types of guarantees based on the current or
some alternative benefit structure.  Such guarantees would, however,
create contingent liabilities and incremental costs for the
government. 

Clearly, the number of proposals and features can make it difficult
to sort out exactly what should be done and what effects various
actions would have on individuals and families, although such effects
may represent the most important considerations in evaluating reform. 
It is critical, therefore, that the extent to which proposals achieve
solvency--
admittedly an easier criterion to measure--not overshadow the balance
of equity and adequacy. 

      CRITERION 3:  IMPLEMENTING
      AND ADMINISTERING PROPOSED
      REFORMS
-------------------------------------------------------- Chapter 0:2.3

Implementation, administration, and public understanding form a third
important area to consider.  Although some consider these issues
merely technical or routine compared with macroeconomic
considerations or concerns about benefit adequacy, implementation and
administration issues are important because they have the potential
to delay--if not derail--reform if they are not considered early
enough for planning purposes.  Moreover, such issues can influence
policy choices--feasibility and cost should be integral factors in
the ultimate decisions regarding the Social Security program.  In
addition, potential transparency and public education needs
associated with various proposals should be considered.  Reforms that
are not well understood could face difficulties in achieving broad
public acceptance and support. 

         FEASIBILITY OF
         IMPLEMENTATION AND
         ADMINISTRATION
------------------------------------------------------ Chapter 0:2.3.1

Degrees of implementation and administrative complexity arise in
virtually all proposed reforms to Social Security.  The extent to
which these issues present true challenges varies with the degree to
which reform proposals step away from current practices.  Hence,
proposals that would make changes to revenues or to benefits without
restructuring the current defined benefit structure of the program
are less difficult to implement and less costly to administer than
those that would create new tiers of benefits or of beneficiaries. 
For example, reducing COLAs, either by improving the accuracy of the
calculation or by limiting COLA increases directly (such as by
capping, delaying, or eliminating the COLA) would not require
significant administrative change.  Similarly, raising the retirement
age, in effect a recalculation of benefits, would not represent a
large increase in ongoing administrative costs, although some
implementation costs would accrue and would include the costs of
educating the public about the changing rules.  Both these changes,
however, would have a ripple effect on certain private sector pension
and saving plans that are integrated with the benefits provided under
Social Security.  If the private sector plan formulas are not
adjusted, these changes would result in additional benefit costs
under the private sector plans.  Alternatively, to the extent that
private sector employers act to adapt their pensions to an altered
Social Security benefit, these actions represent private
administrative costs as yet unmeasured. 

Allowing the government to invest surplus Social Security funds would
raise certain implementation issues, the most significant of which
are investment vehicle and security selection and shareholder voting
rights; relatively less significant concerns regarding cost or
complexity would also be raised.  However, these issues could prove
controversial to resolve because critics have expressed concern about
increased government involvement in financial markets and corporate
affairs.\5

But there may be ways that we can alleviate some of the concerns
about government investing.  One way would be to introduce master
trust principles for collective investment of base defined-benefit or
individual account funds, which would be separate from other
government funds.  In this regard, we might be able to replicate or
piggyback on a model that seems to be working well for federal
workers--the Federal Thrift Savings Plan.  These existing vehicles
might help us limit concerns about the potential for political
manipulation of investment decisions and thus foster the credibility
needed to build bridges to consensus on reforms. 

The greatest potential implementation and administrative challenges
are associated with proposals that would create individual accounts. 
Not all proposals for individual accounts clearly delineate how these
accounts would be administered, but those that do vary in three key
areas: 

  -- the management of the information and money flow needed to
     maintain a system of individual accounts,

  -- the degree of choice and flexibility individuals would have over
     investment options and access to their accounts, and

  -- the mechanisms that would be used to pay out benefits upon
     retirement. 

Decisions in these areas could have a direct effect on system
complexity and who would bear the costs and additional
responsibilities of an individual account system as well as on the
adequacy and certainty of retirement income for future retirees. 
Table 1 provides a snapshot of some of the administrative functions
that would accompany any system of individual accounts, the critical
decisions associated with each function, and a partial list of the
options that could be considered. 

                          Table 1
          
              Design and Administration Issues

              Critical
Administrati  decision or
ve function   trade-off     Options to consider
------------  ------------  ------------------------------
Managing the  Centralized   --Build on current Social
flow of       or            Security tax and payroll
information   decentralize  reporting structure.
and money     d             --Build on employer-based
              recordkeepin  401(k) structure.
              g             --Build on individually
                            controlled IRA structure.

Choosing      Maximizing    --Offer a small set of indexed
investment    individual    funds.
options       choice or     --Offer a broad range of
              minimizing    investment options.
              risk          --Combine the two options by
                            requiring a minimum account
                            balance before a broader range
                            of options is available.

Paying        Maximizing    --Require lifetime annuities.
retirement    individual    --Make annuities voluntary,
benefits      choice or     and permit lump sum and
              ensuring      gradual account withdrawals.
              preservation  --Combine the two options by
              of            requiring annuitization to
              retirement    ensure at least a minimum
              benefits      retirement income, with added
                            flexibility for remainder of
                            account.
----------------------------------------------------------
Essentially, most decisions about the design of a system of
individual accounts amounts to trade-offs between individual choice
and flexibility and simplicity and standardization.  For example, a
centralized recordkeeping system, managed by government, could take
advantage of existing systems and economies of scale but would not
offer the wider range of alternatives for individuals that a
decentralized system would.  A system of individual accounts that
permitted participants full and unfettered choice of investments
would offer an ability to maximize returns but with attendant risk
that incomes would not be adequate.  Alternatively, a more
centralized investment program, with fewer available choices, would
be less administratively complex and would protect participants from
poor investment selection; but it would also raise the risk that
investment decisions could become politicized, depending on the
extent of the government's role in selecting investment funds and
fund managers.  Flexibility in how funds are withdrawn could allow
individuals choice in how to manage their own funds but creates
administrative complexity and risks leaving diminished capital to
support an adequate income throughout retirement.  A full assessment
of the implications of these trade-offs will be essential to the
debate on whether and how to implement individual accounts. 

--------------------
\5 Social Security Financing:  Implications of Government Stock
Investing for the Trust Fund, the Federal Budget, and the Economy
(GAO/AIMD/HEHS-98-74, Apr.  1998). 

         COSTS OF IMPLEMENTATION
         AND ADMINISTRATION
------------------------------------------------------ Chapter 0:2.3.2

Although there are costs associated with most Social Security reform
proposals, debate has focused largely and correctly on the costs of
proposals that involve restructuring for two reasons.  First,
administrative costs of changes within Social Security's current
structure could be relatively insignificant, and adding individual
accounts to the structure creates the potential for much higher
implementation and administrative costs.  For example, there could be
substantial start-up costs associated with an individual account
system.  Second, the risk of higher administrative costs of
individual accounts would be borne by individual account holders,
directly affecting their benefits.  Many have expressed concerns
about the administrative costs of individual accounts and how these
costs would affect accumulations, especially for the small-account
holder.  Each of the reform decisions discussed here today can have a
significant effect on the costs of managing and administering
individual accounts, and it will be important to consider their
effect on the preservation of retirement income. 

Administrative costs would depend on the design choices that were
made.  The more flexibility allowed, the more services provided to
the investor; the more investment options provided, the higher the
administrative costs would be.  For example, offering investors the
option to shift assets frequently from one investment vehicle to
another or offering a toll-free number for a range of customer
investment and education services could significantly increase
administrative costs.  In addition to decisions that affect the level
of administrative costs, other factors would need to be carefully
considered, such as who would bear the costs and how they would be
distributed among large and small accounts. 

To some extent, however, the creation of individual accounts could
help ease administrative burdens in the future.  They would represent
an infrastructure that could allow workers to build up additional
savings to meet future retirement income and health care cost needs
without significant additional implementation and administrative
costs.  For example, workers not covered by a private pension could
choose to contribute more to their individual accounts to augment
their retirement savings.  Workers might also contribute more to
their accounts to help pay health care costs after they retire.  The
accounts could thereby contribute to overall retirement security, not
just retirement income security. 

         PUBLIC UNDERSTANDING
------------------------------------------------------ Chapter 0:2.3.3

Regardless of the reform proposal being considered, there will be a
need for enhanced public education and information.  This effort
would not focus on educating the public about choices for Social
Security reform; that process began some time ago under congressional
and presidential leadership and has raised public consciousness not
only regarding Social Security's financing problems but also of the
choices we face.  Instead, enhanced education and information would
serve to explain what changes have been adopted so that participants
can adjust their retirement planning accordingly.  Retirement
planning is, in its nature, a long-term process, and we must give
Americans not only the time to adapt their plans to a reformed Social
Security program but also the information necessary to do so. 

While any change to the Social Security program must be explained to
the public, the need would be especially acute if individual accounts
were a feature of the chosen reform package.  Not only would
participants need to be informed of this change, they would also
require investor education, especially if individual accounts were
mandatory.  For example, individuals would need information on basic
investment principles, the risks associated with available choices,
and the effect of choosing among alternatives offered for annuitizing
or otherwise withdrawing or borrowing accumulations from the
accounts.  This would be especially important for individuals who are
unfamiliar with making investment choices, including those with lower
incomes and less education, who may have limited investing
experience. 

Public understanding may not necessarily bring about public
acceptance of Social Security reform.  But the credibility of any
reform package will be enhanced to the extent that the American
public understands the changes being made and the impact these
changes have on their personal retirement planning. 

   CONCLUSIONS
---------------------------------------------------------- Chapter 0:3

Restoring solvency to the Social Security system is a formidable
challenge.  Addressing it in a sustainable fashion today could help
us avoid similar challenges in the future rather than leaving
difficult choices for our children.  The health of our economy and
projected budget surpluses offer an historic opportunity to meet
these challenges from a position of financial and economic strength. 
Such good fortune can indeed help us meet our historic
responsibility--a fiduciary obligation, if you will--to leave our
nation's future generations a financially stable system.  We must
also move forward to address Social Security because we have other,
equally serious obligations before us--compared to addressing the
health-care financing problem, reforming Social Security is easy
lifting. 

Today, I have offered three basic criteria against which Social
Security reform proposals may be measured.  These may not be the same
criteria every analyst would suggest, and certainly how policymakers
weight the various elements may vary.  But if comprehensive proposals
are evaluated as to (1) their financing and economic effects, (2)
their effects on individuals, and (3) their feasibility, we will have
a good foundation for devising agreeable solutions, perhaps not in
every detail, but as an overall reform package that will meet the
most important of our objectives. 

I believe it is possible to reform Social Security in a way that will
exceed the expectations of all generations of Americans.  The reports
about Social Security's long-term solvency problem and the challenges
it represents have caused many Americans to have decidedly low
expectations about the future of their Social Security benefits. 
Many current retirees and those nearing retirement believe that their
benefits will need to be cut to restore solvency, while some baby
boomers and many generation Xers are doubtful that the program will
be there for them when they retire.  We believe it is possible to
craft a solution that will protect Social Security benefits for the
nation's current retirees, while ensuring that the system will be
there for future generations.  Perhaps the answer is not solely one
approach or another--such as defined benefit versus defined
contribution.  Bridging the gap between these approaches is not
beyond our ability.  Doing so would represent a major accomplishment
that would benefit future generations.  It would also help to restore
the public's respect for and confidence in its government.  GAO and I
stand ready to provide the information and analysis that can help the
Congress meet this challenge in a way that can exceed the
expectations of all generations of Americans. 

Mr.  Chairman, this concludes my remarks.  I would be happy to answer
any questions you or other Members of the Committee may have. 

ELEMENTS FOR EVALUATING SOCIAL
SECURITY REFORMS
==================================================== Appendix Appendix

      FINANCING SUSTAINABLE
      SOLVENCY
------------------------------------------------ Appendix Appendix:0.1

To what extent does the proposal

  -- restore 75-year actuarial balance? 

  -- create a stable system beyond the 75-year period? 

  -- increase national saving? 

  -- reduce debt held by the public? 

  -- draw on general revenues to finance changes? 

  -- use Social Security trust fund surpluses to finance changes? 

  -- result in a future budget deficit? 

  -- require an increase in taxes? 

  -- create contingent liabilities? 

      BALANCING ADEQUACY AND
      EQUITY
------------------------------------------------ Appendix Appendix:0.2

To what extent does the proposal

  -- provide reasonable minimum benefits to minimize poverty among
     the elderly? 

  -- provide adequate support for the disabled, dependents, and
     survivors? 

  -- provide higher replacement rates for low-income workers? 

  -- ensure that those who contribute receive benefits? 

  -- provide a reasonable return on investment? 

  -- expand individual choice and control? 

  -- improve intergenerational equity? 

  -- provide an opportunity to enhance individual wealth? 

  -- set reasonable targets as to the percentage of the current and
     projected economy and the federal budget, represented by these
     costs? 

  -- provide safety valves to control future program growth? 

      IMPLEMENTING AND
      ADMINISTERING REFORMS
------------------------------------------------ Appendix Appendix:0.3

To what extent does the proposal

  -- provide a reasonable amount of time and adequate funding for
     implementation? 

  -- result in reasonable ongoing administrative costs? 

  -- allow the general public to readily understand its financing
     structure, thereby increasing public confidence? 

  -- allow the general public to readily understand the benefit
     structure, thereby avoiding expectation gaps? 

  -- limit the potential for politically motivated investment
     decisions? 

*** End of document. ***