Social Security Reform
Analysis of a Trust Fund Exhaustion Scenario Illustrates the Difficult Choices and the Need for Early Action Gao ID: GAO-03-1038T July 29, 2003Social Security is an important social insurance program affecting virtually every American family. It is the foundation of the nation's retirement income system and also provides millions of Americans with disability insurance and survivors' benefits. Over the long term, as the baby boom generation retires, Social Security's financing shortfall presents a major program solvency and sustainability challenge. The Chairman of the Senate Special Committee on Aging asked GAO to discuss Social Security's long-term financing challenges and the results of GAO's analysis of an illustrative "Trust Fund Exhaustion" scenario. Under this scenario, benefits are reduced proportionately for all beneficiaries by the shortfall in revenues occurring upon exhaustion of the combined Old-Age and Survivors Insurance and Disability Insurance Trust Funds. This scenario was developed for analytic purposes and is not a legal determination of how benefits would be paid in the event of trust fund exhaustion. GAO's analysis used the framework it has developed to analyze the implications of reform proposals. This framework consists of three criteria: (1) the extent to which the proposal achieves sustainable solvency and how it would affect the U.S. economy and the federal budget, (2) the balance struck between the twin goals of income adequacy and individual equity, and (3) how readily changes could be implemented, administered, and explained to the public.
Although the Trustees' 2003 intermediate estimates show that the combined Social Security Trust Funds will be solvent until 2042, program spending will constitute a growing share of the budget and the economy much sooner. Within 5 years, the first baby boomers will become eligible for Social Security. By 2018, Social Security's tax income is projected to be insufficient to pay currently scheduled benefits. This shift from positive to negative cash flow will place increased pressure on the federal budget to raise the resources necessary to meet the program's ongoing costs. In the long term, Social Security, together with rapidly growing federal health programs, will dominate our nation's fiscal outlook. Absent reform, the nation will ultimately have to choose between persistent, escalating federal deficits, significant tax increases, and/or dramatic budget cuts of unprecedented magnitude. The Trust Fund Exhaustion scenario we analyzed dramatically illustrates the need for action sooner rather than later. (See Social Security Reform: Analysis of a Trust Fund Exhaustion Scenario. GAO-03-907. Washington, D.C.: July 29, 2003.) Under this scenario, after the combined trust funds had been fully depleted, benefit payments would be adjusted each year to equal annual tax income. Under this scenario, after trust fund exhaustion those receiving benefits would experience large and sudden benefit reductions. Additional smaller reductions in the following years would result in benefits equal to about two-thirds of currently scheduled levels by the end of the 75-year simulation period. The Trust Fund Exhaustion scenario raises significant intergenerational equity issues. The timing of the benefit adjustments means the Trust Fund Exhaustion scenario places a much greater burden on younger generations. Lifetime benefits would be reduced much more for younger generations. In addition, under the Trust Fund Exhaustion scenario, benefits would be adjusted proportionately for all recipients, increasing the likelihood of hardship for lower income retirees and the disabled, especially those who rely on Social Security as their primary or sole source of retirement income. Fundamentally, the Trust Fund Exhaustion scenario illustrates trade-offs between achieving sustainable solvency and maintaining benefit adequacy. The longer we wait to take action, the sharper these trade-offs will become. Acting soon would allow changes to be phased in so the individuals who are most likely to be affected, namely younger and future workers, will have time to adjust their retirement planning while helping to avoid related "expectation gaps." Finally, acting soon reduces the likelihood that the Congress will have to choose between imposing severe benefit cuts and unfairly burdening future generations with the program's rising costs.
GAO-03-1038T, Social Security Reform: Analysis of a Trust Fund Exhaustion Scenario Illustrates the Difficult Choices and the Need for Early Action
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Testimony:
Before the Special Committee on Aging U.S. Senate:
United States General Accounting Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Tuesday, July 29, 2003:
Social Security Reform:
Analysis of a Trust Fund Exhaustion Scenario Illustrates the Difficult
Choices and the Need for Early Action:
Statement of David M. Walker
Comptroller General of the United States:
GAO-03-1038T:
GAO Highlights:
Highlights of GAO-03-1038T, a testimony for the Special Committee on
Aging, United States Senate
Why GAO Did This Study:
Social Security is an important social insurance program affecting
virtually every American family. It is the foundation of the nation‘s
retirement income system and also provides millions of Americans with
disability insurance and survivors‘ benefits. Over the long term, as
the baby boom generation retires, Social Security‘s financing
shortfall presents a major program solvency and sustainability
challenge.
The Chairman of the Senate Special Committee on Aging asked GAO to
discuss Social Security‘s long-term financing challenges and the
results of GAO‘s analysis of an illustrative ’Trust Fund Exhaustion“
scenario. Under this scenario, benefits are reduced proportionately
for all beneficiaries by the shortfall in revenues occurring upon
exhaustion of the combined Old-Age and Survivors Insurance and
Disability Insurance Trust Funds. This scenario was developed for
analytic purposes and is not a legal determination of how benefits
would be paid in the event of trust fund exhaustion. GAO‘s analysis
used the framework it has developed to analyze the implications of
reform proposals. This framework consists of three criteria: (1) the
extent to which the proposal achieves sustainable solvency and how it
would affect the U.S. economy and the federal budget, (2) the balance
struck between the twin goals of income adequacy and individual
equity, and (3) how readily changes could be implemented,
administered, and explained to the public.
What GAO Found:
Although the Trustees‘ 2003 intermediate estimates show that the
combined Social Security Trust Funds will be solvent until 2042,
program spending will constitute a growing share of the budget and the
economy much sooner. Within 5 years, the first baby boomers will
become eligible for Social Security. By 2018, Social Security‘s tax
income is projected to be insufficient to pay currently scheduled
benefits. This shift from positive to negative cash flow will place
increased pressure on the federal budget to raise the resources
necessary to meet the program‘s ongoing costs. In the long term,
Social Security, together with rapidly growing federal health
programs, will dominate our nation‘s fiscal outlook. Absent reform,
the nation will ultimately have to choose between persistent,
escalating federal deficits, significant tax increases, and/or
dramatic budget cuts of unprecedented magnitude.
The Trust Fund Exhaustion scenario we analyzed dramatically
illustrates the need for action sooner rather than later. (See Social
Security Reform: Analysis of a Trust Fund Exhaustion Scenario. GAO-03-
907. Washington, D.C.: July 29, 2003.) Under this scenario, after the
combined trust funds had been fully depleted, benefit payments would
be adjusted each year to equal annual tax income. Under this scenario,
after trust fund exhaustion those receiving benefits would experience
large and sudden benefit reductions. Additional smaller reductions in
the following years would result in benefits equal to about two-thirds
of currently scheduled levels by the end of the 75-year simulation
period.
The Trust Fund Exhaustion scenario raises significant
intergenerational equity issues. The timing of the benefit adjustments
means the Trust Fund Exhaustion scenario places a much greater burden
on younger generations. Lifetime benefits would be reduced much more
for younger generations. In addition, under the Trust Fund Exhaustion
scenario, benefits would be adjusted proportionately for all
recipients, increasing the likelihood of hardship for lower income
retirees and the disabled, especially those who rely on Social
Security as their primary or sole source of retirement income.
Fundamentally, the Trust Fund Exhaustion scenario illustrates trade-
offs between achieving sustainable solvency and maintaining benefit
adequacy. The longer we wait to take action, the sharper these trade-
offs will become. Acting soon would allow changes to be phased in so
the individuals who are most likely to be affected, namely younger and
future workers, will have time to adjust their retirement planning
while helping to avoid related ’expectation gaps.“ Finally, acting
soon reduces the likelihood that the Congress will have to choose
between imposing severe benefit cuts and unfairly burdening future
generations with the program‘s rising costs.
[End of section]
Mr. Chairman and Members of the Committee:
Thank you for inviting me here to talk about our nation's Social
Security program. Social Security not only represents the foundation of
our retirement income system; it also provides millions of Americans
with disability insurance and survivors' benefits. As a result, Social
Security provides benefits that are critical to the current and future
well-being of tens of millions of Americans. As I have said in
congressional testimonies over the past several years,[Footnote 1] this
important program faces both solvency and sustainability challenges in
the longer term that require our attention today.
Last January, I testified before this Committee on the need for early
action to reform Social Security.[Footnote 2] That testimony presented
GAO's analysis of the reform models developed by the President's
Commission to Strengthen Social Security. Since that time, the Social
Security Trustees have issued their 2003 report, which showed that the
program's financial condition remains virtually unchanged since last
year. Under the Trustees' 2003 intermediate estimates, the actuarial
balance of the combined trust funds[Footnote 3] over the 75-year period
deteriorated from last year's estimate of -1.87 percent of taxable
payroll to this year's estimate of -1.92 percent of taxable payroll.
The present value of this actuarial deficit is $3.8 trillion over the
75-year period. Absent legislative action, within 15 years projected
Social Security outlays will begin to exceed projected tax receipts,
and by 2042 the combined Old-Age and Survivors Insurance and Disability
Insurance (OASDI) trust funds are projected to be exhausted. These new
estimates once more underscore the program's unsustainability as Social
Security continues to await reform.
Today we are issuing a report you requested using the same criteria and
framework we used in our report on the Commission reform models to
analyze the potential effects over the long term if no program reform
takes place. [Footnote 4] For this analysis, we applied our criteria to
a scenario in which the Trust Fund reaches exhaustion, after which only
benefits equal to cash available from program income are paid. The
scenario illustrates some potential outcomes of a lack of action to
address the serious imbalance between Social Security's projected
revenues and the costs of paying currently scheduled benefits.
Before I summarize the findings from this analysis, let me first
highlight a number of important points in connection with the Social
Security challenge.
* Focusing on trust fund solvency alone is not sufficient. We need to
put the program on a path toward sustainable solvency. Trust fund
solvency is an important concept, but focusing on trust fund solvency
alone can lead to a false sense of security about the overall condition
of the Social Security program. The size of the trust fund does not
tell us whether the program is sustainable--that is, whether the
government will have the capacity to pay future claims or what else
will have to be squeezed to pay those claims. Aiming for sustainable
solvency would increase the chance that future policymakers would not
have to face these difficult questions on a recurring basis. Estimates
of what it would take to achieve 75-year trust fund solvency understate
the extent of the problem because the program's financial imbalance
gets worse in the 76th and subsequent years.[Footnote 5]
* Social Security reform is part of a broader fiscal and economic
challenge. If you look ahead in the federal budget, the combined Social
Security or OASDI program together with the rapidly growing health
programs (Medicare and Medicaid) will dominate the federal government's
future fiscal outlook. Under GAO's long-term simulations it continues
to be the case that these programs increasingly constrain federal
budgetary flexibility over the next few decades. Absent reform, the
nation will ultimately have to choose between persistent, escalating
federal deficits, significant tax increases, and/or dramatic budget
cuts.
* Solving Social Security's long-term financing problem is more
important and complex than simply making the numbers add up. Social
Security is an important and successful social program that affects
virtually every American family. It currently pays benefits to more
than 46 million people, including retired workers, disabled workers,
the spouses and children of retired and disabled workers, and the
survivors of deceased workers. The number of individuals receiving
benefits is expected to grow to over 68 million by 2020. The program
has been highly effective at reducing the incidence of poverty among
the elderly, and the disability and survivor benefits have been
critical to the financial well-being of millions of others.
* Acting sooner rather than later would help to ease the difficulty of
change. As I noted previously, the challenge of facing the imminent and
daunting budget pressure from Medicare, Medicaid, and OASDI increases
over time. Social Security will begin to constrain the budget long
before the trust funds are exhausted in 2042. The program's annual cash
flow is projected to be negative beginning in 2018. Social Security's
annual cash deficit will place increasing pressure on the rest of the
budget to raise the resources necessary to meet the program's costs.
Waiting until Social Security faces an immediate solvency crisis will
limit the scope of feasible solutions and could reduce the options to
only those choices that are the most difficult. It could also
contribute to further delay the really tough decisions on health
programs (e.g., Medicare, Medicaid). Acting soon would allow changes to
be phased in so the individuals who are most likely to be affected,
namely younger and future workers, will have time to adjust their
retirement planning while helping to avoid related "expectation gaps."
It would also help to assure that the "miracle of compounding" works
for us rather than against us. Finally, acting soon reduces the
likelihood that the Congress will have to choose between imposing
severe benefit cuts and unfairly burdening future generations with the
program's rising costs.
The Trust Fund Exhaustion scenario analyzed in our report[Footnote 6]
dramatically illustrates the need for action sooner rather than later.
Under this scenario, once the combined trust funds had been fully
depleted, benefit payments would be adjusted each year to equal annual
tax income. [Footnote 7] After trust fund exhaustion, those receiving
benefits would experience a large and sudden benefit reduction of about
27 percent (to 73 percent of currently scheduled levels) in
2039.[Footnote 8] By the end of the 75-year period, smaller reductions
in successive years after trust fund exhaustion would mean that
benefits would be about two-thirds of what they would have been under
current benefit formulas (or 67 percent of currently scheduled levels).
The Trust Fund Exhaustion scenario raises significant intergenerational
equity issues. The timing of the benefit adjustments means the Trust
Fund Exhaustion scenario places a much greater burden on younger
generations. For example, those born in 1955 would receive currently
scheduled benefits until they reached age 83, while those born in 1985
would always receive benefits in retirement lower than currently
scheduled benefits. This means that lifetime benefits would be reduced
more for younger generations. In addition, under the Trust Fund
Exhaustion scenario, benefits would be adjusted proportionately for all
recipients, increasing the likelihood of hardship for lower income
retirees and the disabled, especially those who rely on Social Security
as their primary or sole source of retirement income.
As we all know, fixing Social Security is about more than finances. It
is also about maintaining an adequate safety net for American workers
against loss of income from retirement, disability, or death. Social
Security provides a foundation of retirement income for millions of
Americans and has prevented many former workers and their families from
living their retirement years in poverty. Proposals to restore the
long-term financial stability and viability of the Social Security
system must also be considered in terms of how potential changes affect
different types of beneficiaries. The Trust Fund Exhaustion scenario
illustrates trade-offs between the criterion of achieving sustainable
solvency and the criterion of maintaining benefit adequacy and equity.
The longer we wait to take action, the sharper these trade-offs will
become. We need to put the program on a path toward sustainable
solvency as soon as possible to assure that future policymakers would
not have to face these difficult questions on a recurring basis.
I hope my testimony will help clarify some of the key issues in the
debate about how to restructure this critically important program.
Social Security's Long-Term Financing Problem Is Truly Urgent:
Today the Social Security program faces a long-range and fundamental
financing problem driven largely by known demographic trends. The lack
of an immediate solvency crisis affects the nature of the challenge,
but it does not eliminate the need for action. Acting soon reduces the
likelihood that the Congress will have to choose between imposing
severe benefit cuts and unfairly burdening future generations with the
program's rising costs. Acting soon would allow changes to be phased in
so the individuals who are most likely to be affected, namely younger
and future workers, will have time to adjust their retirement planning.
Since there is a great deal of confusion about Social Security's
current financing arrangements and the nature of its long-term
financing problem, I would like to spend some time describing the
nature, timing, and extent of the financing problem.
Demographic Trends Drive Social Security's Long-Term Financing Problem:
As you all know, Social Security has always been largely a pay-as-you-
go system. This means that current workers' taxes pay current retirees'
benefits. As a result, the relative numbers of workers and
beneficiaries has a major impact on the program's financial condition.
This ratio, however, is changing. In 1950, before the Social Security
system was mature, the ratio was 16.5:1. In the 1960s, the ratio
averaged 4.2:1. Today it is 3.3:1 and it is expected to drop to around
2.2:1 by 2030. The retirement of the baby boom generation is not the
only demographic challenge facing the system. People are retiring early
and living longer. A falling fertility rate is the other principal
factor underlying the growth in the elderly's share of the population.
In the 1960s, the fertility rate was an average of 3 children per
woman. Today it is a little over 2, and by 2030 it is expected to fall
to 1.95 --a rate that is below replacement. Taken together, these
trends threaten the financial solvency and sustainability of this
important program. (See fig. 1.):
Figure 1: Social Security Workers per Beneficiary:
[See PDF for image]
Note: Projections based on the intermediate assumptions of the 2003
Trustees' Report.
[End of figure]
The combination of these trends means that labor force growth will
begin to slow after 2010 and by 2025 is expected to be less than a
third of what it is today. (See fig. 2.) Relatively fewer workers will
be available to produce the goods and services that all will consume.
Without a major increase in productivity, low labor force growth will
lead to slower growth in the economy and to slower growth of federal
revenues. This in turn will only accentuate the overall pressure on the
federal budget.
Figure 2: Labor Force Growth Is Expected to be Negligible by 2050:
[See PDF for image]
Note: GAO analysis based on the intermediate assumptions of The 2003
Annual Report of the Board of Trustees of the Federal Old-Age and
Survivors Insurance and the Federal Disability Insurance Trust Funds.
Percentage change is calculated as a centered 5-year moving average.
[End of figure]
This slowing labor force growth is not always recognized as part of the
Social Security debate. Social Security's retirement eligibility dates
are often the subject of discussion and debate and can have a direct
effect on both labor force growth and the condition of the Social
Security retirement program. However, it is also appropriate to
consider whether and how changes in pension and/or other government
policies could encourage longer workforce participation. To the extent
that people choose to work longer as they live longer, the increase in
the share of life spent in retirement would be slowed. This could
improve the finances of Social Security and mitigate the expected
slowdown in labor force growth.
Social Security's Cash Flow Is Expected To Turn Negative in 2018:
Today, the Social Security Trust Funds take in more in taxes than they
spend. Largely because of the known demographic trends I have
described, this situation will change. Although the Trustees' 2003
intermediate estimates project that the combined Social Security Trust
Funds will be solvent until 2042,[Footnote 9] program spending will
constitute a rapidly growing share of the budget and the economy well
before that date. In 2008, the first baby boomers will become eligible
for Social Security benefits, and the future costs of serving them are
already becoming a factor in the Congressional Budget Office's (CBO)
10-year projections. Under the Trustees' 2003 intermediate estimates,
Social Security's cash surplus--the difference between program tax
income and the costs of paying scheduled benefits--will begin a
permanent decline in 2009. To finance the same level of federal
spending as in the previous year, additional revenues and/or increased
borrowing will be needed.
By 2018, Social Security's tax income is projected to be insufficient
to pay currently scheduled benefits. At that time, Social Security will
join Medicare's Hospital Insurance Trust Fund (whose outlays are
projected to begin to exceed revenues in 2013) as a net claimant on the
rest of the federal budget. The combined OASDI Trust Funds will begin
drawing on the Treasury to cover the cash shortfall, first relying on
interest income and eventually drawing down accumulated trust fund
assets. The Treasury will need to obtain cash for those redeemed
securities either through increased taxes, and/or spending cuts, and/or
more borrowing from the public than would have been the case had Social
Security's cash flow remained positive.[Footnote 10] Neither the
decline in the cash surpluses nor the cash deficit will affect the
payment of benefits. The shift from positive to negative cash flow,
however, will place increased pressure on the federal budget to raise
the resources necessary to meet the program's ongoing costs.
Figure 3: Social Security's (OASDI) Trust Funds Face Cash Deficits as
Baby Boomers Retire:
[See PDF for image]
[End of figure]
Ultimately, the critical question is not how much a trust fund has in
assets, but whether the government as a whole can afford the benefits
in the future and at what cost to other claims on scarce resources. As
I have said before, the future sustainability of programs is the key
issue policymakers should address--i.e., the capacity of the economy
and budget to afford the commitment. Fund solvency can help, but only
if promoting solvency improves the future sustainability of the
program.
Decline in Budgetary Flexibility Absent Entitlement Reform:
From the perspective of the federal budget and the economy, the
challenge posed by the growth in Social Security spending becomes even
more significant in combination with the more rapid expected growth in
Medicare and Medicaid spending. This growth in spending on federal
entitlements for retirees will become increasingly unsustainable over
the longer term, compounding an ongoing decline in budgetary
flexibility. Over the past few decades, spending on mandatory programs
has consumed an ever-increasing share of the federal budget. In 1963,
prior to the creation of the Medicare and Medicaid programs, spending
for mandatory programs plus net interest accounted for about 32 percent
of total federal spending. By 2003, this share had almost doubled to
approximately 61 percent of the budget. (See fig. 4.):
Figure 4: Federal Spending for Mandatory and Discretionary Programs,
Fiscal Years 1963, 1983, and 2003:
[See PDF for image]
*Estimate for 2003 includes $41 billion in discretionary spending and
about $1 billion in mandatory spending for the Iraq war supplemental.
Includes $11 billion in mandatory spending for the Jobs and Growth Tax
Relief Reconciliation Act of 2003.
[End of figure]
In much of the last decade, reductions in defense spending helped
accommodate the growth in these entitlement programs. Even before the
events of September 11, 2001, however, this ceased to be a viable
option. Indeed, spending on defense and homeland security will grow as
we seek to combat new threats to our nation's security.
GAO prepares long-term budget simulations that seek to illustrate the
likely fiscal consequences of the coming demographic tidal wave and
rising health care costs. These simulations continue to show that to
move into the future with no changes in federal retirement and health
programs is to envision a very different role for the federal
government. Assuming, for example, that the tax reductions enacted in
2001 do not sunset and discretionary spending keeps pace with the
economy, by midcentury federal revenues may only be adequate to pay
Social Security and interest on the federal debt.[Footnote 11] To
obtain balance, massive spending cuts, tax increases, or some
combination of the two would be necessary. (See fig. 5.) Neither
slowing the growth of discretionary spending nor allowing the tax
reductions to sunset eliminates the imbalance.
Figure 5: Composition of Spending as a Share of Gross Domestic Product
(GDP) Assuming Discretionary Spending Grows with GDP, the 2001 Tax Cuts
Do Not Sunset, and Payment of Currently Scheduled Social Security
Benefits:
[See PDF for image]
Note: Assumes currently scheduled Social Security benefits are paid in
full throughout the simulation period. Social Security and Medicare
projections are based on the Trustees' 2003 intermediate assumptions.
[End of figure]
Although this figure assumes payment of currently scheduled Social
Security benefits, the long-term fiscal imbalance would not be
eliminated even if Social Security benefits were to be limited to
currently projected trust fund revenues. This is because Medicare (and
Medicaid)--spending for which is driven by both demographics and rising
health care costs--present an even greater problem.
This testimony is not about the complexities of Medicare, but it is
important to note that Medicare presents a much greater, more complex,
and more urgent fiscal challenge than does Social Security. Medicare
growth rates reflect not only a burgeoning beneficiary population, but
also the escalation of health care costs at rates well exceeding
general rates of inflation. Increases in the number and quality of
health care services have been fueled by the explosive growth of
medical technology. Moreover, the actual costs of health care
consumption are not transparent. Third-party payers generally insulate
consumers from the cost of health care decisions. These factors and
others contribute to making Medicare a much greater and more complex
fiscal challenge than even Social Security. GAO is developing a health
care framework to help focus additional attention on this important
area and to help educate key policymakers and the public on the current
system and related challenges.
Indeed, long-term budget flexibility is about more than Social Security
and Medicare. While these programs dominate the long-term outlook, they
are not the only federal programs or activities that bind the future.
The federal government undertakes a wide range of programs,
responsibilities, and activities that obligate it to future spending or
create an expectation for spending. A recent GAO report describes the
range and measurement of such fiscal exposures--from explicit
liabilities such as environmental cleanup requirements to the more
implicit obligations presented by life-cycle costs of capital
acquisition or disaster assistance.[Footnote 12] Making government fit
the challenges of the future will require not only dealing with the
drivers--entitlements for the elderly--but also looking at the range of
federal activities. A fundamental review of what the federal government
does and how it does it will be needed.
At the same time it is important to look beyond the federal budget to
the economy as a whole. Figure 6 shows the total future draw on the
economy represented by Social Security, Medicare, and Medicaid. Under
the 2003 Trustees' intermediate estimates and CBO's long-term Medicaid
estimates, spending for these entitlement programs combined will grow
to 14 percent of GDP in 2030 from today's 8.4 percent. Taken together,
Social Security, Medicare, and Medicaid represent an unsustainable
burden on future generations.
Figure 6: Social Security, Medicare, and Medicaid Spending as a Percent
of GDP:
[See PDF for image]
Note: Projections based on the intermediate assumptions of the 2003
Trustees' Reports, CBO's March 2003 short-term Medicaid estimates, and
CBO's June 2002 long-term Medicaid projections under midrange
assumptions.
[End of figure]
When Social Security redeems assets to pay benefits, the program will
constitute a claim on real resources in the future. As a result, taking
action now to increase the future pool of resources is important. To
echo Federal Reserve Chairman Greenspan, the crucial issue of saving in
our economy relates to our ability to build an adequate capital stock
to produce enough goods and services in the future to accommodate both
retirees and workers in the future.[Footnote 13] The most direct way
the federal government can raise national saving is by increasing
government saving, i.e., as the economy returns to a higher growth
path, a much more balanced and disciplined fiscal policy that
recognizes our long-term challenges can help provide a strong
foundation for future economic growth and can enhance future budgetary
flexibility. In the short term, we need to realize that we are already
facing a huge fiscal hole (gap). The first thing that we should do is
stop digging.
Taking action now on Social Security would not only promote increased
budgetary flexibility in the future and stronger economic growth but
would also make less dramatic action necessary than if we wait. Some of
the benefits of early action--and the costs of delay--can be seen in
figure 7. This compares what it would take to achieve actuarial balance
at different points in time by either raising payroll taxes or reducing
benefits.[Footnote 14] If we did nothing until 2042--the year the Trust
Funds are estimated to be exhausted--achieving actuarial balance would
require changes in benefits of 31 percent or changes in taxes of 46
percent. As figure 7 shows, earlier action shrinks the size of the
adjustment.
Figure 7: Size of Action Needed to Achieve Social Security Solvency:
[See PDF for image]
Note: Based on the intermediate assumptions of the 2003 Trustees'
Report. The benefit adjustments in this graph represent a one-time,
permanent change to all existing and future benefits beginning in the
first year indicated.
[End of figure]
Thus both sustainability concerns and solvency considerations drive us
to act sooner rather than later. Trust Fund exhaustion may be almost 40
years away, but the squeeze on the federal budget will begin as the
baby boom generation starts to retire. Actions taken today can ease
both these pressures and the pain of future actions. Acting sooner
rather than later also provides a more reasonable planning horizon for
future retirees.
Evaluating Social Security Reform Proposals:
As important as financial stability may be for Social Security, it
cannot be the only consideration. As a former public trustee of Social
Security and Medicare, I am well aware of the central role these
programs play in the lives of millions of Americans. Social Security
remains the foundation of the nation's retirement system. It is also
much more than just a retirement program; it pays benefits to disabled
workers and their dependents, spouses and children of retired workers,
and survivors of deceased workers. Last year, Social Security paid
almost $454 billion in benefits to more than 46 million people. Since
its inception, the program has successfully reduced poverty among the
elderly. In 1959, 35 percent of the elderly were poor. In 2000, about 8
percent of beneficiaries aged 65 or older were poor, and 48 percent
would have been poor without Social Security. It is precisely because
the program is so deeply woven into the fabric of our nation that any
proposed reform must consider the program in its entirety, rather than
one aspect alone. Thus, GAO has developed a broad framework for
evaluating reform proposals that considers not only solvency but other
aspects of the program as well.
The analytic framework GAO has developed to assess proposals comprises
three basic criteria:
* the extent to which a proposal achieves sustainable solvency and how
it would affect the economy and the federal budget;
* the relative balance struck between the goals of individual equity
and income adequacy; and:
* how readily a proposal could be implemented, administered, and
explained to the public.
The weight that different policymakers may place on different criteria
will vary, depending on how they value different attributes. For
example, if offering individual choice and control is less important
than maintaining replacement rates for low-income workers, then a
reform proposal emphasizing adequacy considerations might be preferred.
As they fashion a comprehensive proposal, however, policymakers will
ultimately have to balance the relative importance they place on each
of these criteria.
Financing Sustainable Solvency:
Our sustainable solvency standard encompasses several different ways of
looking at the Social Security program's financing needs. While 75-year
actuarial balance is generally used in evaluating the long-term
financial outlook of the Social Security program and reform proposals,
it is not sufficient in gauging the program's solvency after the 75th
year. For example, under the Trustees' intermediate assumptions, each
year the 75-year actuarial period changes, and a year with a surplus is
replaced by a new 75th year that has a significant deficit. As a
result, changes made to restore trust fund solvency only for the 75-
year period can result in future actuarial imbalances almost
immediately. Reform plans that lead to sustainable solvency would be
those that consider the broader issues of fiscal sustainability and
affordability over the long term. Specifically, a standard of
sustainable solvency also involves looking at (1) the balance between
program income and cost beyond the 75th year and (2) the share of the
budget and economy consumed by Social Security spending.
As I have already discussed, reducing the relative future burdens of
Social Security and health programs is essential to a sustainable
budget policy for the longer term. It is also critical if we are to
avoid putting unsupportable financial pressures on future workers.
Reforming Social Security and federal health programs is essential to
reclaiming our future fiscal flexibility to address other national
priorities.
Balancing Adequacy and Equity:
The current Social Security system's benefit structure strikes a
balance between the goals of retirement income adequacy and individual
equity. From the beginning, benefits were set in a way that focused
especially on replacing some portion of workers' preretirement
earnings. Over time other changes were made that were intended to
enhance the program's role in helping ensure adequate incomes.
Retirement income adequacy, therefore, is addressed in part through the
program's progressive benefit structure, providing proportionately
larger benefits to lower earners and certain household types, such as
those with dependents. Individual equity refers to the relationship
between contributions made and benefits received. This can be thought
of as the rate of return on individual contributions. Balancing these
seemingly conflicting objectives through the political process has
resulted in the design of the current Social Security program and
should still be taken into account in any proposed reforms.
Policymakers could assess income adequacy, for example, by considering
the extent to which proposals ensure benefit levels that are adequate
to protect beneficiaries from poverty and ensure higher replacement
rates for low-income workers. In addition, policymakers could consider
the impact of proposed changes on various subpopulations, such as low-
income workers, women, minorities, and people with disabilities.
Policymakers could assess equity by considering the extent to which
there are reasonable returns on contributions at a reasonable level of
risk to the individual, improved intergenerational equity, and
increased individual choice and control. Differences in how various
proposals balance each of these goals will help determine which
proposals will be acceptable to policymakers and the public.
Implementing and Administering Proposed Reforms:
Program complexity makes implementation and administration both more
difficult and harder to explain to the public. Some degree of
implementation and administrative complexity arises in virtually all
proposed changes to Social Security, even those that make incremental
changes in the already existing structure. However, the greatest
potential implementation and administrative challenges are associated
with proposals that would create individual accounts. These include,
for example, issues concerning the management of the information and
money flow needed to maintain such a system, the degree of choice and
flexibility individuals would have over investment options and access
to their accounts, investment education and transitional efforts, and
the mechanisms that would be used to pay out benefits upon retirement.
Harmonizing a system that includes individual accounts with the
regulatory framework that governs our nation's private pension system
would also be a complicated endeavor. However, the complexity of
meshing these systems should be weighed against the potential benefits
of extending participation in individual accounts to millions of
workers who currently lack private pension coverage.
Continued public acceptance and confidence in the Social Security
program require that any reforms and their implications for benefits be
well understood. This means that the American people must understand
why change is necessary, what the reforms are, why they are needed, how
they are to be implemented and administered, and how they will affect
their own retirement income. All reform proposals will require some
additional outreach to the public so that future beneficiaries can
adjust their retirement planning accordingly. The more transparent the
implementation and administration of reform, and the more carefully
such reform is phased in, the more likely it will be understood and
accepted by the American people.
Social Security's Long-Term Financing Shortfall Requires Action Sooner
Rather Than Later:
As you requested, we applied our criteria to a scenario of Trust Fund
Exhaustion. This scenario dramatically illustrates the need to take
action sooner rather than later to address the program's long-term
fiscal imbalance. Under this scenario, currently scheduled benefits
would be paid in full until the combined OASDI Trust Funds are
exhausted. After exhaustion, monthly benefit checks are reduced in
proportion to the annual shortfall. In effect, after trust fund
exhaustion, all beneficiaries would experience a sharp drop in
benefits. Additional reductions in the following years would result in
benefits equal to about two-thirds of currently scheduled levels by the
end of the 75-year simulation period. (See fig. 8.):
Figure 8: Change in Currently Scheduled Benefits under the Trust Fund
Exhaustion Scenario:
[See PDF for image]
[End of figure]
We used our long-term economic model in assessing the Trust Fund
Exhaustion scenario against the first criterion, that of financing
sustainable solvency. To examine how the Commission reform models
balance adequacy and equity concerns, we used the GEMINI model, a
dynamic microsimulation model for analyzing the lifetime implications
of Social Security policies for a large sample of people born in the
same year. Our analysis examined the effects of the reform models for
the 1955, 1970, and 1985 birth cohorts. For this analysis, as in our
report on the Commission reform models, we used the 2001 Trustees'
intermediate assumptions. Under these assumptions, the combined trust
funds are projected to reach exhaustion in 2038.
Our analysis of the scenario used the same three benchmarks as in our
January report on the Commission reform models:[Footnote 15]
* The "benefit reduction benchmark" assumes a gradual reduction in the
currently scheduled Social Security defined benefit beginning with
those newly eligible for retirement in 2005. Current tax rates are
maintained.
* The "tax increase benchmark" assumes an increase in the OASDI payroll
tax beginning in 2002 sufficient to achieve an actuarial balance over
the 75-year period. Currently scheduled benefits are maintained.
[Footnote 16]
* The "baseline extended benchmark" is a fiscal policy path developed
in our earlier long-term model work that assumes payment in full of
currently scheduled Social Security benefits and no other changes in
current spending or tax policies. [Footnote 17]
The use of our criteria in evaluating the Trust Fund Exhaustion
scenario underscores the need to take action sooner rather than later
to address Social Security's financing shortfall. In so doing, it
illustrates trade-offs that exist between efforts to achieve
sustainable solvency for the OASDI Trust Funds and efforts to maintain
adequate retirement income for current and future beneficiaries.
By definition this scenario would achieve sustainable solvency because
after the combined trust funds had run out of assets, benefit payments
would be adjusted each year to equal annual tax income. Before 2038,
the Trust Fund Exhaustion scenario would result in lower unified
surpluses and higher unified deficits compared to the tax increase
benchmark by the same amounts as the baseline extended benchmark.
Subsequently the Trust Fund Exhaustion scenario would result in unified
fiscal results increasingly similar to both the tax increase benchmark
and the benefit reduction scenario over the 75-year period. Before
2038, the Trust Fund Exhaustion scenario would require the same amounts
of cash as the tax increase or baseline extended benchmarks;
subsequently, the Trust Fund Exhaustion scenario would require less
cash each year than any of the three benchmarks.
Under the Trust Fund Exhaustion scenario, the effect on benefits would
differ sharply before and after exhaustion took place. Before
exhaustion, benefits would be the same as those currently scheduled,
reflected in both the tax increase and baseline extended benchmarks.
Once the combined trust funds had run out, benefits for all would be
reduced across the board and remain below currently scheduled levels.
Accordingly, those receiving benefits at the time of trust fund
exhaustion would experience a sharp drop in benefits; under the
Trustees' 2001 intermediate estimates, this drop is estimated at 27
percent (to 73 percent of currently scheduled levels) in 2039. Small
further reductions would need to be taken in successive years such that
by 2076 benefits would be only two-thirds of currently scheduled levels
(i.e., to 67 percent of currently scheduled levels). (See fig. 9.):
Figure 9: Monthly Benefits Under the Trust Fund Exhaustion Scenario for
an Illustrative Individual by Selected Birth Year:
[See PDF for image]
Note: Illustrative workers retire at age 65 and receive benefits equal
to the median for the appropriate GEMINI cohort under the Trust Fund
Exhaustion scenario. In years after 2038, real benefits are reduced
according to the Trust Fund Exhaustion scenario. In GEMINI, the median
age of death for those living to age 65 years and receiving a retired
workers benefit is 84, 85, and 86, for the 1955, 1970, and 1985
cohorts, respectively.
[End of figure]
Due to the timing of the reductions under the Trust Fund Exhaustion
scenario, younger generations would bear greater benefit reductions.
Those born in 1955 would not experience benefit reductions until they
reached age 83, while those born in 1985 would receive lower benefits
than under either GAO's benefit reduction or tax increase benchmarks in
all years of retirement. Consequently, lifetime benefits would be
reduced more for younger generations. Under the Trust Fund Exhaustion
scenario we used, benefits would be adjusted proportionately for all
recipients, increasing the likelihood of hardship for lower income
retirees and the disabled.
Given a lack of historical precedent and legislative clarity on how SSA
would proceed in the event of trust fund exhaustion, the nature and
scope of SSA's administrative challenges under the scenario are
difficult to describe or assess. At a minimum, a focus on cash
management would be needed for SSA to calculate and implement the
ongoing benefit adjustments required under the scenario.
Conclusion: Choices and Trade-Offs Will Be Part of Any Social Security
Reform--Acting Soon Would Help:
It is likely that the structural changes required to restore Social
Security's long-term viability generally will require some combination
of reductions from currently scheduled benefits, revenue increases, and
may include the use of some general revenues. The proposals we have
examined, both this year and earlier, generally reflect this. Proposals
employ possible benefit modifications within the current program
structure, including modifying the benefit formula, reconsidering
current eligibility criteria, and reducing cost-of-living adjustments.
Revenue increases might take the form of increases in the payroll tax
rate, expanding coverage to include the relatively few workers who are
still not covered under Social Security, or allowing the trust funds to
be invested in potentially higher-yielding securities such as
stocks.[Footnote 18] Similarly, some proposals rely on general revenue
transfers to increase the amount of money going towards the Social
Security program. Reforms that include individual accounts would also
involve Social Security benefit reductions and/or revenue increases,
and the use of general revenues. Whatever approach is taken to reform,
we must be able to continue to finance ongoing benefits to retirees in
the short term. The longer we delay reform, the larger the "transition
costs" and the more disruptive the actions will be.
In evaluating Social Security reform proposals, the choice among
various benefit reductions and revenue increases will affect the
balance between income adequacy and individual equity. Benefit
reductions could pose the risk of diminishing adequacy, especially for
specific subpopulations. Both benefit reductions and tax increases that
have been proposed could diminish individual equity by reducing the
implicit rates of return the workers earn on their contributions to the
system. In contrast, increasing revenues by investing retirement funds
in the stock market could improve rates of return but potentially
expose individuals to investment risk and losses of expected retirement
income.
Similarly, the choice among various benefit reductions and revenue
increases--for example, raising the retirement age--will ultimately
determine not just how much income retirees will have but also how long
they will be expected to continue working and how long their
retirements will be. Reforms will determine how much consumption
workers will give up during their working years to provide for more
consumption during retirement.
The use of our criteria to evaluate approaches to Social Security
reform highlights the trade-offs that exist between efforts to achieve
sustainable solvency and to maintain adequate retirement income for
current and future beneficiaries. These trade-offs can be described as
differences in the extent and nature of the risks for individuals and
the nation as a whole.
At the same time, the defined benefit under the current Social Security
system is also uncertain. The primary risk is that a significant
funding gap exists between currently scheduled and funded benefits
which, although it will not occur for a number of years, is significant
and will grow over time. Other risks stem from uncertainty in, for
example, future levels of productivity growth, real wage growth, and
demographics. The Congress has revised Social Security many times in
the past, and future Congresses could decide to revise benefits in ways
that leave those affected little time to adjust. As the Congress
deliberates various approaches to Social Security, the national debate
also needs to include discussion of the various types of risk implicit
in each approach and in the timing of reform.
Early action to change these programs would yield the highest fiscal
dividends for the federal budget and would provide a longer period for
prospective beneficiaries to make adjustments in their own planning.
Waiting to build economic resources and reform future claims entails
risks. First, we lose an important window where today's relatively
large workforce can increase saving and enhance productivity, two
elements critical to growing the future economy. We lose the
opportunity to reduce the burden of interest payments, thereby creating
a legacy of higher debt as well as elderly entitlement spending for the
relatively smaller workforce of the future. Most critically, we risk
losing the opportunity to phase in changes gradually so that all can
make the adjustments needed in private and public plans to accommodate
this historic shift. Unfortunately, the long-range challenge has become
more difficult, and the window of opportunity to address the
entitlement challenge is narrowing.
As the baby boom generation retires and the numbers of those entitled
to these retirement benefits grow, the difficulties of reform will be
compounded. Accordingly, it remains more important than ever to deal
with these issues over the next several years. In their March 2003
report, the Trustees emphasized the need for action sooner rather than
later, stating that the sooner Social Security's financial challenges
are addressed, the more varied and less disruptive can be their
solutions.
Today many retirees and near-retirees fear cuts that will affect them
while young people believe they will get little or no Social Security
benefits. As I have said before, I believe it is possible to structure
a Social Security reform proposal that will exceed the expectations of
all generations of Americans. In my view there is a window of
opportunity to craft a solution that will protect Social Security
benefits for the nation's current and near-term retirees, while
ensuring that the system will be there for future generations. However,
this window of opportunity will close as the baby boom generation
begins to retire. As a result, we must move forward to address Social
Security because we have other major challenges confronting us. The
fact is, compared to addressing our long-range health care financing
problem; reforming Social Security will be easy lifting.
It is my hope that we will think about the unprecedented challenge
facing future generations in our aging society. Relieving them of some
of the burden of today's financing commitments would help fulfill this
generation's stewardship responsibility to future generations. It would
also preserve some capacity for them to make their own choices by
strengthening both the budget and the economy they inherit. We need to
act now to address the structural imbalances in Social Security,
Medicare, and other entitlement programs before the approaching
demographic tidal wave makes the imbalances more difficult, dramatic,
and disruptive.
We at GAO look forward to continuing to work with this Committee and
the Congress in addressing this and other important issues facing our
nation.
Mr. Chairman, Members of the Committee, that concludes my statement.
I'd be happy to answer any questions you may have.
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FOOTNOTES
[1] U.S. General Accounting Office, Social Security: Criteria for
Evaluating Social Security Reform Proposals, GAO/T-HEHS-99-94
(Washington, D.C.: Mar. 25, 1999); Social Security: The President's
Proposal, GAO/T-HEHS/AIMD-00-43 (Washington, D.C.: Nov. 9, 1999);
Budget Issues: Long-Term Fiscal Challenges, GAO-02-467T (Washington,
D.C.: Feb. 27, 2002); Social Security: Long-Term Financing Shortfall
Drives Need for Reform GAO-02-845T (Washington, D.C.: June 19, 2002).
[2] U.S. General Accounting Office, Social Security: Analysis of Issues
and Selected Reform Proposals, GAO-3-376T (Washington, D.C.: Jan. 15,
2003).
[3] In this testimony, the term "trust funds" refers to the combined
Old-Age and Survivors Insurance and Disability Insurance (OASDI) Trust
Funds.
[4] As in our report on the Commission reform models, we used the 2001
Trustees' intermediate assumptions in analyzing the Trust Fund
Exhaustion scenario.
[5] In addition to assessing a proposal's likely effect on Social
Security's actuarial balance, a standard of sustainable solvency
involves looking at (1) the balance between program income and cost
beyond the 75th year and (2) the share of the budget and economy
consumed by Social Security spending.
[6] U.S. General Accounting Office, Social Security Reform: Analysis of
a Trust Fund Exhaustion Scenario, GAO-03-907 (Washington, D.C.: July
29, 2003).
[7] The Trust Fund Exhaustion scenario is intended as an analytic tool,
not a legal determination.
[8] In our analysis of the Trust Fund Exhaustion scenario, as in our
January report on the Commission models, we used the Trustees' 2001
intermediate assumptions, under which the combined OASDI trust funds
are projected to reach exhaustion in 2038. Under the 2001 intermediate
assumptions, in 2038 the benefit reduction would be about 7 percent
because trust fund assets would be available for part of the year to
pay benefits. In 2039, the first full year after trust fund exhaustion,
benefits would fall sharply, to about 27 percent (or 73 percent of
currently scheduled levels). Under the Trustees' 2003 intermediate
assumptions, the projected exhaustion date for the combined trust funds
is 2042, and the overall drop is approximately the same.
[9] Separately, the DI fund is projected to be exhausted in 2028 and
the OASI fund in 2044.
[10] If the unified budget is in surplus at this point, then financing
the excess benefits will require less debt redemption rather than
increased borrowing.
[11] This simulation assumes that all currently scheduled benefits
would be paid in full throughout the 75-year projection period. The
simulation does not reflect the effects of any legislation enacted
after March 2003, e.g., the tax reductions in the Jobs and Growth Tax
Relief Reconciliation Act of 2003.
[12] U.S. General Accounting Office, Fiscal Exposures: Improving the
Budgetary Focus on Long-Term Costs and Uncertainties, GAO-03-213
(Washington, D.C.: Jan. 24, 2003).
[13] Testimony before the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, July 24, 2001.
[14] Solvency could also be achieved through a combination of tax and
benefit actions. This would reduce the magnitude of the required change
in taxes or benefits compared to making changes exclusively to taxes or
benefits as shown in figure 7.
[15] From the perspective of analyzing benefit adequacy, the tax
increase and baseline extended benchmarks are identical because both
assume payment in full of scheduled Social Security benefits over the
75-year simulation period.
[16] Our benchmarks are solvent for the 75-year projection period
commonly used by the Social Security Administration's (SSA) Office of
the Chief Actuary, but they do not achieve sustainable solvency. Both
the benefit reduction and tax increase benchmarks are explicitly fully
funded and we worked closely with SSA's Chief Actuary in their design.
[17] Implicitly, therefore, after exhaustion benefits are paid in part
by increased borrowing from the public.
[18] About 4 percent of the workforce remains uncovered, which mostly
includes some state and local government employees and federal
employees hired before 1984.
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