Social Security
Reform Proposals Could Have a Variety of Effects on Distribution of Benefits and Payroll Taxes
Gao ID: GAO-04-872T June 15, 2004
Under the current Social Security benefit formula, retired workers can receive benefits at age 65 that equal about 50 percent of preretirement earnings for an illustrative low-wage worker but only about 30 percent for an illustrative high-wage worker. Factors other than earnings also influence the distribution of benefits, including the program's provisions for disabled workers, spouses, children, and survivors. Changes in the program over time also affect the distribution of benefits across generations. Social Security faces a long-term structural financing shortfall. Program changes to address that shortfall could alter the way Social Security's benefits and revenues are distributed across the population and affect the income security of millions of Americans. The Chairman of the Senate Special Committee on Aging asked us to discuss how selected Social Security reform proposals might affect the distribution of benefits and taxes.
Two distinct perspectives on Social Security's goals suggest different approaches to measuring "progressivity," or the distribution of benefits and taxes with respect to various earnings levels. Both perspectives provide valuable insights. An adequacy perspective focuses on benefit levels and how well they maintain pre-retirement living standards. An equity perspective focuses on rates of return and other measures relating lifetime benefits to contributions. Both perspectives examine how their measures are distributed across earnings levels. However, equity measures take all benefits and taxes into account, which is difficult to calculate for reform proposals that rely on general revenue transfers because it is unclear who will bear the relative burden for those general revenues. The Social Security program's distributional effects reflect both program features and demographic patterns among its recipients. In addition to the benefit formula, disability benefits favor lower earners because disabled workers are more likely to be lower lifetime earners. In contrast, certain household patterns reduce the system's tilt toward lower earners, for example, when lower earners have high-earner spouses. The advantage for lower earners is also diminished by the fact that they may not live as long as higher earners and therefore would get benefits for fewer years on average. Proposals to alter the Social Security program would have different distributional effects, depending on their design. Model 2 of the President's Commission to Strengthen Social Security proposes new individual accounts, certain benefit reductions for all beneficiaries, and certain benefit enhancements for selected low earners and survivors. According to our simulations, the combined effect could result in lower earners receiving a greater relative share of all benefits than under the current system if all workers invest in the same portfolio.
GAO-04-872T, Social Security: Reform Proposals Could Have a Variety of Effects on Distribution of Benefits and Payroll Taxes
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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, June 15, 2004:
SOCIAL SECURITY:
Reform Proposals Could Have a Variety of Effects on Distribution of
Benefits and Payroll Taxes:
Statement of David M. Walker,
Comptroller General of the United States:
GAO-04-872T:
GAO Highlights:
Highlights of GAO-04-872T, a testimony for the Special Committee on
Aging, United States Senate
Why GAO Did This Study:
Under the current Social Security benefit formula, retired workers can
receive benefits at age 65 that equal about 50 percent of pre-
retirement earnings for an illustrative low-wage worker but only about
30 percent for an illustrative high-wage worker. Factors other than
earnings also influence the distribution of benefits, including the
program‘s provisions for disabled workers, spouses, children, and
survivors. Changes in the program over time also affect the
distribution of benefits across generations.
Social Security faces a long-term structural financing shortfall.
Program changes to address that shortfall could alter the way Social
Security‘s benefits and revenues are distributed across the population
and affect the income security of millions of Americans.
The Chairman of the Senate Special Committee on Aging asked us to
discuss how selected Social Security reform proposals might affect the
distribution of benefits and taxes.
What GAO Found:
Two distinct perspectives on Social Security‘s goals suggest different
approaches to measuring ’progressivity,“ or the distribution of
benefits and taxes with respect to various earnings levels. Both
perspectives provide valuable insights. An adequacy perspective focuses
on benefit levels and how well they maintain pre-retirement living
standards. An equity perspective focuses on rates of return and other
measures relating lifetime benefits to contributions. Both perspectives
examine how their measures are distributed across earnings levels.
However, equity measures take all benefits and taxes into account,
which is difficult to calculate for reform proposals that rely on
general revenue transfers because it is unclear who will bear the
relative burden for those general revenues.
The Social Security program‘s distributional effects reflect both
program features and demographic patterns among its recipients. In
addition to the benefit formula, disability benefits favor lower
earners because disabled workers are more likely to be lower lifetime
earners. In contrast, certain household patterns reduce the system‘s
tilt toward lower earners, for example, when lower earners have high-
earner spouses. The advantage for lower earners is also diminished by
the fact that they may not live as long as higher earners and therefore
would get benefits for fewer years on average.
Proposals to alter the Social Security program would have different
distributional effects, depending on their design. Model 2 of the
President‘s Commission to Strengthen Social Security proposes new
individual accounts, certain benefit reductions for all beneficiaries,
and certain benefit enhancements for selected low earners and
survivors. According to our simulations, the combined effect could
result in lower earners receiving a greater relative share of all
benefits than under the current system if all workers invest in the
same portfolio.
Social Security Benefit Formula Provides Higher Replacement Rates for
Lower Earners:
[See PDF for image]
Notes: Replacement rates are the annual retired worker benefits at age
65 for workers born in 1985 divided by the earnings in the previous
year. For such workers, the full retirement age will be 67. Steady
earners have earnings equal to various percentages of Social Security‘s
Average Wage Index in every year of their careers.
[End of figure]
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[End of section]
Mr. Chairman and Members of the Committee:
Thank you for inviting me here today to discuss the potential effects
of selected Social Security reform proposals.[Footnote 1] Social
Security not only represents the foundation of our retirement income
system; it also provides millions of Americans with disability
insurance and survivor's benefits. As a result, Social Security
provides benefits that are critical to the current and future well-
being of virtually all Americans. However, as I have said in
congressional testimonies over the past several years,[Footnote 2] the
system faces both solvency and sustainability challenges in the longer
term. The challenges of combating terrorism have come to the fore as
urgent claims on the federal budget. At the same time, Social
Security's long-term pressures on the budget have not diminished.
Indeed, our long-range challenges are greater than ever. Without
substantive reforms, Social Security and Medicare are unsustainable,
and their long-term impact on the federal budget and the economy will
be dramatic.
Social Security faces a long-term structural financing shortfall
largely because people are living longer and having fewer children.
According to the 2004 intermediate--or best-estimate--assumptions of
the Social Security trustees, Social Security's annual benefit payments
will exceed annual cash revenues beginning in 2018, and it will be
necessary to draw on trust fund reserves to pay full benefits. To do
this, 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. In 2042, the trust funds will be
exhausted, and annual revenues will only be sufficient to pay about 73
percent of benefits. As a result, some combination of benefit and/or
revenue changes will be needed to restore the long-term solvency and
sustainability of the program.
Last July, I testified before this committee on the need for early
action to reform Social Security and specifically how failing to do so
would place a burden on younger generations, lower earners, and the
disabled. In point of fact, any reform proposal will have implications
for how benefits and related taxes are distributed across the entire
population. Today, we are issuing a report you requested to examine
such distributional effects, specifically those effects relative to
various earnings levels. I hope my testimony today will help illustrate
the potential distributional effects of Social Security reforms and
will place such effects in a broader context.
Before I summarize the findings from this analysis, let me first
highlight a number of important points in connection with our Social
Security challenge.
* Social Security reform is part of a broader fiscal and economic
challenge. If you look ahead in the federal budget, the combined Social
Security program (Old-Age and Survivors Insurance and Disability
Insurance), together with the rapidly growing health programs (Medicare
and Medicaid), will dominate the federal government's future fiscal
outlook. Absent reform, the nation will ultimately have to choose
between persistent, escalating federal deficits and debt, huge tax
increases and/or dramatic budget cuts.
* 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 policy makers 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 each subsequent year.[Footnote 3]
* 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. 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 ensure 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.
To assist the Congress in its deliberations, GAO has developed criteria
for evaluating various Social Security reform proposals. These criteria
aim to balance financial and economic considerations with benefit
adequacy and equity issues and the administrative challenges associated
with various proposals. The use of these criteria can help facilitate
fair consideration and informed debate about Social Security reform
proposals.
To help ensure adequate incomes, Social Security's benefit provisions
are designed to favor lower earners, disabled workers, and workers with
dependents. Changes in the program over time also affect the
distribution of benefits and taxes across generations. So, Social
Security's distributional effects can vary by eligibility, household
type, and birth year, as well as by earnings level. Our focus today is
the distribution of benefits and taxes relative to various earnings
levels, or "progressivity." Two distinct perspectives on Social
Security's goals suggest different approaches to measuring
progressivity, and both provide valuable insights. One perspective
focuses on measures of the adequacy of benefits while the other focuses
on "equity" measures, such as internal rates of return. The measures
themselves describe either adequacy or equity, but their distribution
with respect to earnings level describes progressivity. However, when
proposals use general revenue transfers, estimating equity measures
becomes difficult because such proposals do not generally specify what
kind of future taxes or spending cuts will finance the transfers or who
will bear the related burden.
The Social Security program's distributional effects reflect both
program features and demographic patterns among its recipients. While
the benefit formula and disability provisions favor lower earners,
household and mortality patterns serve to reduce the system's tilt
toward lower earners.
Alternative Social Security reform proposals would have different
distributional effects, reflecting the variety of provisions in them.
The various provisions include different ways, within the current
program structure, of reducing certain benefits, enhancing selected
benefits, and enhancing revenues. Certain reform provisions also
include creating a new system of individual retirement savings accounts
with different account contribution levels and different ways of
adjusting Social Security defined benefits to reflect the diversion of
Social Security contributions into the accounts. Individually and in
combination, these provisions would affect the distribution of benefits
and taxes relative to various earnings levels.
Social Security's Long-Term Financing Problem Deserves Timely Action:
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 generally pay current
retirees' benefits. As a result, the relative number 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 the level necessary to replace the
population. Taken together, these trends serve to 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: This is based on the intermediate assumptions of the 2004 Social
Security trustees' reports.
[End of figure]
The combination of these trends means that annual 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: This analysis is based on the intermediate assumptions of the
2004 Social Security trustees' report. 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. It could also help to encourage
additional economic 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' 2004
intermediate estimates project that the combined Social Security Trust
Funds will be solvent until 2042,[Footnote 4] 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 have
already become a factor in the Congressional Budget Office's (CBO) 10-
year projections. Under the trustees' 2004 intermediate estimates,
Social Security's cash surplus--the difference between program tax
income and the costs of paying scheduled benefits--will begin 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 this year, 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 5]
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]
Note: These projections are based on the intermediate assumptions of
the 2004 Social Security trustees' report.
[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 policy makers 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 1964,
prior to the creation of the Medicare and Medicaid programs, spending
for mandatory programs plus net interest accounted for about 33 percent
of total federal spending. By 2004, this share had almost doubled to
approximately 61 percent of the budget. (See fig. 4.):
Figure 4: Federal Spending for Mandatory and Discretionary Programs,
Fiscal Years 1964, 1984, and 2004:
[See PDF for image]
[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 likely
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, all expiring tax provisions are
extended and discretionary spending keeps pace with the economy, by
midcentury federal revenues may be adequate to pay no more than
interest on the federal debt. 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:
Figure 5: Composition of Spending as a Share of Gross Domestic Product
(GDP), Assuming Discretionary Spending Grows with GDP after 2004 and
All Expiring Tax Provisions Are Extended:
[See PDF for image]
Note: Although expiring tax provisions are extended, revenue as a share
of GDP increases through 2014 due to (1) real bracket creep, (2) more
taxpayers becoming subject to the Alternative Minimum Tax, and (3)
increased revenue from tax-deferred retirement accounts. After 2014,
revenue as a share of GDP is held constant.
[End of figure]
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 has developed a health
care framework to help focus additional attention on this important
area and to help educate key policy makers and the public on the
current system and related challenges.[Footnote 6]
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. GAO has described the range and
measurement of such fiscal exposures--from explicit liabilities such as
environmental cleanup requirements to the more implicit obligations
presented by life-cycle costs of capital acquisition or disaster
assistance.[Footnote 7] 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 2004 Trustees' intermediate estimates and CBO's long-term Medicaid
estimates, spending for these entitlement programs combined will grow
to 15.6 percent of GDP in 2030 from today's 8.5 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
Percentage of GDP:
[See PDF for image]
Note: Social Security and Medicare projections are based on the
intermediate assumptions of the 2004 trustees' reports. Medicaid
projections are based on CBO's January 2004 short-term Medicaid
estimates and CBO's December 2003 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 at that time. 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 8] 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. The first thing that we should do is stop
digging.
Taking action soon on Social Security would not only promote increased
budgetary flexibility in the future and stronger economic growth but
would also make the necessary action less dramatic than if we wait.
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 9] 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 30 percent or changes in
taxes of 43 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: This is based on the intermediate assumptions of the 2004 Social
Security trustees' report. The benefit adjustments in this graph
represent a one-time, permanent change to all existing and future
benefits beginning in the first year indicated.
[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 $471 billion in benefits to more than 47 million people. Since
its inception, the program has successfully reduced poverty among the
elderly. In 1959, 35 percent of the elderly were poor. In 2000, about 8
percent of beneficiaries aged 65 or older were poor, and 48 percent
would have been poor without Social Security. It is precisely because
the program is so deeply woven into the fabric of our nation that any
proposed reform must consider the program in its entirety, rather than
one aspect alone. Thus, GAO has developed a 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 policy makers may place on different criteria
will vary, depending on how they value different attributes. For
example, if offering individual choice and control is less important
than maintaining replacement rates for low-income workers, then a
reform proposal emphasizing adequacy considerations might be preferred.
As they fashion a comprehensive proposal, however, policy makers will
ultimately have to balance the relative importance they place on each
of these criteria.
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 costs 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 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 attempts to
strike 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' pre-retirement
earnings. Over time other changes were made that were intended to
enhance the program's role in helping ensure adequate incomes.
Retirement income adequacy, therefore, is addressed in part through the
program's progressive benefit structure, providing proportionately
larger benefits to lower earners and certain household types, such as
those with dependents. Individual equity refers to the relationship
between contributions made and benefits received. This can be thought
of as the rate of return on individual contributions. Balancing these
seemingly conflicting objectives through the political process has
resulted in the design of the current Social Security program and
should still be taken into account in any proposed reforms.
Policy makers 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, policy makers could consider
the impact of proposed changes on various subpopulations, such as low-
income workers, women, minorities, and people with disabilities. Policy
makers 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 policy makers 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 of and confidence in the Social Security
program require that any reforms and their implications for benefits be
well understood. This means that the American people must understand
why change is necessary, what the reforms are, why they are needed, how
they are to be implemented and administered, and how they will affect
their own retirement income. All reform proposals will require some
additional outreach to the public so that future beneficiaries can
adjust their retirement planning accordingly. The more transparent the
implementation and administration of reform, and the more carefully
such reform is phased in, the more likely it will be understood and
accepted by the American people.
Examining Social Security's Effects on Distribution of Benefits and
Taxes:
Under Social Security, retired workers can receive benefits at age 65
that equal about 50 percent of pre-retirement earnings for an
illustrative worker with relatively lower earnings but only about 30
percent of earnings for one with relatively higher earnings. To help
ensure that beneficiaries have adequate incomes, Social Security's
benefit formula is designed to be "progressive," that is, to provide
disproportionately larger benefits, as a percentage of earnings, to
lower earners than to higher earners. However, the benefit formula is
just one of several program features that influence the way benefits
are distributed. Other such program features include provisions for
disabled workers, spouses, children, and survivors. Changes in the
program over time also affect the distribution of benefits across
generations. So the distribution of Social Security benefits can vary
by eligibility, household type, and birth year as well as by earnings
level.
Over the past few years, we have been developing an increasing capacity
at GAO to estimate quantitatively the effects of Social Security reform
on individuals. Such estimates speak directly to applying our second
evaluation criterion to reform proposals. We have just issued a new
report that, in part, uses such estimates to illustrate the varying
effects of different policy scenarios on how Social Security benefits
and taxes are distributed relative to earnings levels.[Footnote 10]
Today, I would like to share our findings regarding how to define and
describe "progressivity," defining appropriate benchmarks for
assessing the future outlook for individuals' Social Security benefits,
what factors influence the distributional effects of the current Social
Security program, and how various reform proposals might vary in their
distributional effects. Still, remember that progressivity is only one
of several aspects of our criterion of balancing adequacy and equity,
which in turn is only one of three criteria that each consist of
several dimensions.
Different Distributional Measures Reflect Different Perspectives:
Two distinct perspectives on Social Security's goals suggest different
approaches to measuring progressivity. Both perspectives provide
valuable insights. An adequacy perspective focuses on benefit levels
and how well they help ensure a minimal subsistence or maintain pre-
entitlement living standards. For example, replacement rates measure
annual benefits as a percentage of annual earnings before receiving
benefits. An equity perspective focuses on rates of return and other
measures relating lifetime benefits to lifetime contributions. This
perspective gauges whether the system gives all participants a "fair
deal" on their contributions. The measures themselves describe either
adequacy or equity, but their distribution with respect to earnings
level describes progressivity. Note however that equity measures cannot
accurately assess the distributional effects of reform proposals that
rely on general revenue transfers. Such proposals do not generally
specify what kind of future taxes or spending cuts will finance the
transfers or who will bear the related burden; but evaluating
progressivity from an equity perspective requires that all taxes and
benefits be clearly allocated.
Benchmark Policy Scenarios Illustrate a Range of Possible Outcomes:
Estimating future effects on Social Security benefits should reflect
the fact that the program faces a long-term actuarial deficit and
benefit reductions and/or revenue increases will be necessary to
restore solvency. To illustrate a full range of possible outcomes, we
developed hypothetical benchmark policy scenarios that would restore
solvency over the next 75 years either by only increasing payroll taxes
or by only reducing benefits. Our tax-increase-only benchmark simulates
"promised benefits," or those benefits defined under current law, while
our benefit-reduction-only benchmarks simulate "funded benefits," or
those benefits for which currently scheduled revenues are projected to
be sufficient. The benefit reductions are phased in between 2005 and
2035 to strike a balance between the size of the incremental reductions
each year and the size of the ultimate reduction. At our request,
Social Security actuaries scored our benchmark policies and determined
the parameters for each that would achieve 75-year solvency. For our
benefit reduction scenarios, the actuaries determined these parameters
assuming that disabled and survivor benefits would be reduced on the
same basis as retired worker and dependent benefits. If disabled and
survivor benefits were not reduced at all, reductions in other benefits
would be deeper than shown in this analysis.[Footnote 11]
Program's Distributional Effects Reflect Various Program Features and
Demographic Patterns:
Social Security's distributional effects reflect program features, such
as its benefit formula, and demographic patterns among its recipients,
such as marriage between lower and higher earners. The retired worker
benefit formula favors lower earners by design, replacing about 50
percent of pre-retirement earnings at age 65 for an illustrative low
earner but only about 30 percent of pre-retirement earnings for an
illustrative high earner.[Footnote 12] (See fig. 8.) The disability
benefit formula also favors lower earners, and disability recipients
are disproportionately lower earners. Our simulations suggest that for
individuals born in 1985, compared with a hypothetical program without
disability insurance, Social Security's disability provisions increase
lifetime Social Security benefits for the bottom fifth of earners by 43
percent, compared with 14 percent for the top fifth of earners. The
extent to which the benefit formula and disability benefits favor lower
earners may be offset to some degree by demographic patterns. Household
formation tends to reduce the system's tilt toward lower earners
because some of the lower-earning individuals helped by the program
live in high-income households. For example, many of the lower-earning
individuals that the system favors through spouse and survivor benefits
actually live at some point in higher-income households because of
marriage. In our simulations, the ratio of benefits received to payroll
taxes contributed is higher for lower earners than for higher earners,
but this difference is reduced when we account for household formation.
Also, differences in mortality rates may reduce rates of return for
lower earners, as studies show they may not live as long as higher
earners and therefore would receive benefits for fewer years.
Figure 8: Social Security Benefit Formula Provides Higher Replacement
Rates for Lower Earners:
[See PDF for image]
Note: Replacement rates are the annual retired worker benefits at age
65 for workers born in 1985 divided by the earnings in the previous
year. For such workers, the full retirement age will be 67. Steady
earners have earnings equal to a constant percentage of Social
Security's Average Wage Index in every year of their careers. Those
percentages are 45, 100, and 160, respectively, for low, average, and
high earners. Taxable maximum earners have earnings equal to the
maximum taxable earnings in each year. Replacement rates are simulated
under the tax-increase benchmark (promised benefits); they would be
lower under the proportional benefit-reduction benchmark by a constant
proportion and would therefore show a similar pattern. See appendix I
for more on the benchmark policy scenarios.
[End of figure]
Distributional Effects Vary across Reform Proposals:
Alternative Social Security reform proposals would have different
distributional effects, reflecting the variety of provisions in them.
The various provisions include different ways, within the current
program structure, of reducing certain benefits, enhancing selected
benefits, and enhancing revenues. The various reform provisions also
include creating a new system of individual retirement savings accounts
with different account contribution levels and different ways of
adjusting Social Security defined benefits to reflect the diversion of
Social Security contributions into the accounts. Individually and in
combination, these provisions would affect the distribution of benefits
and taxes relative to earnings levels.
For example, Model 2 of the President's Commission to Strengthen Social
Security (CSSS) proposes a new system of voluntary individual accounts
along with a combination of certain benefit reductions for all
beneficiaries and selected benefit enhancements for selected low
earners and survivors. One of its provisions would reduce Social
Security defined benefits proportionally for all workers by modifying
the benefit formula. At the same time, benefits would be enhanced for
certain lower earners and surviving spouses, and 4 percentage points of
individuals' payroll taxes (up to a $1,000 annual limit[Footnote 13])
would be diverted into individual accounts.
In contrast, a proposal offered by Peter Diamond and Peter Orszag would
also include a provision to reduce Social Security defined benefits
proportionally for all workers by modifying the benefit formula. It
also has provisions to enhance benefits for selected lower earners and
surviving spouses. However, it does not contain a provision for
individual accounts, and it does have a variety of provisions for
enhancing revenues. The Diamond-Orszag proposal also has other benefit
reduction and benefit enhancement provisions, such as modifying the
benefit formula to reduce benefits for higher earners only. Another
provision would maintain disability benefits and benefits for survivors
of workers who die before retirement in spite of the other benefit
reductions.
Also in contrast to CSSS Model 2, a proposal offered by Peter Ferrara
provides for a new system of voluntary individual accounts but does not
contain any provisions to make changes to Social Security defined
benefits, except for individuals participating in the individual
accounts. Moreover, it would provide for substantially larger
contributions to the accounts than would the CSSS Model 2 proposal.
Under this provision, individual account contributions would be a
larger percentage of payroll for lower earners than for higher earners.
Also, for those who participate in the accounts, Social Security
defined benefits would be reduced to reflect the payroll taxes
redirected into the accounts; this account offset uses a different
formula than does CSSS Model 2.
To illustrate the distributional effects of CSSS Model 2, we used a
microsimulation model to estimate benefits under it and under our
benchmark policy scenarios. We did not examine the distribution of
equity measures such as benefit-to-tax ratios or rates of return,
because the proposal's individual account feature requires general
revenue transfers.[Footnote 14] Since account participation is
voluntary, we used two simulations to examine the effects of the Model
2 provisions, one with universal account participation (Model 2-
100 percent) and one with no account participation (Model 2-0 percent).
We also assumed that all account participants would invest in the same
portfolios; consequently we did not capture any distributional effect
that might occur if lower earners were to make different account
participation or investment decisions than higher earners.[Footnote 15]
According to our simulations, the distribution of benefits under Model
2 could favor lower earners more than the distribution of benefits
under either currently promised or currently funded benefits. For
example, assuming universal account participation, households in the
lowest fifth of earnings may receive about 14 percent of all lifetime
benefits under Model 2, compared with about 12.5 percent under the
current program. (See fig. 9.):
Figure 9: CSSS Model 2 Might Favor Lower Earners More than Benchmarks
for Individuals Born in 1985:
[See PDF for image]
Note: Earnings fifths are based on the present value of total household
lifetime earnings. Household analysis is based on per capita benefits,
taxes, and earnings. This includes all sample members who survive past
age 24. It assumes all account participants choose the same portfolio-
-50 percent equities, 30 percent corporate bonds, and 20 percent
Treasury bonds. Accounts earn a constant real return of 4.6 percent.
For sensitivity analysis, we also simulated scenarios with rates of
return varying stochastically across individuals and over time and
scenarios with higher and lower returns to equities. Shares of benefits
by earning fifths were similar under all specifications.
[End of figure]
It should be noted that while the simulations suggest that the
distribution of benefits under Model 2 is more progressive than under
the benchmarks, this does not mean benefit levels are always higher for
the bottom fifth under Model 2. Progressivity is about how the "pie" is
divided up, not about how big the pie is. So, while Model 2 may improve
the relative position of lower earners, it may not improve the adequacy
of their benefits. (See fig. 10.) According to our simulation, median
household lifetime benefits for the bottom fifth under Model 2-0
percent would be 3 percent higher than under the funded benefits
scenario but 21 percent lower than under the promised benefits
scenario. Median household lifetime benefits for the bottom fifth under
Model 2-100 percent would be 26 percent higher than under the funded
benefits scenario but 4 percent lower than under the promised benefits
scenario.
Figure 10: Median Household Lifetime Benefits under Model 2 and the
Benchmarks for Individuals Born in 1985:
[See PDF for image]
Note: Earnings fifths are based on the present value of total household
lifetime earnings. Household analysis is based on per capita benefits,
taxes, and earnings. This includes all sample members who survive past
age 24. It assumes all account participants choose the same portfolio-
-50 percent equities, 30 percent corporate bonds, and 20 percent
Treasury bonds. Accounts earn a constant real return of 4.6 percent.
[End of figure]
We also simulated each of Model 2's core features, assuming 100 percent
participation in the individual accounts, to illustrate the
distributional effect of each feature. (See fig. 11.) First we
simulated a version of Model 2-100 percent that included the individual
accounts and the reductions in Social Security defined benefits, but
not the $1,000 cap on account contributions or the enhanced benefits
for low earners and survivors. Next we simulated a version that
included the defined-benefit reductions and the individual accounts
with the $1,000 cap on account contributions. Finally, we simulated the
complete Model 2-100 percent scenario, which included the enhanced
benefits to lower earners and survivors. While the proposal's
individual accounts and benefit reductions together may favor higher
earners, this is more than offset by a limit on account contributions
and the enhanced benefits for low earners and survivors. Again, this
assumes that all account participants would invest in the same
portfolios. However, if individuals' investment decisions varied by
earnings level, then the distribution of income from the accounts would
differ from our simulations.
Figure 11: CSSS Model 2's Contribution Cap and Enhanced Benefits for
Lower Earners and Survivors Offset the Distributional Effect of the
Accounts and Reductions in Social Security Defined Benefits:
[See PDF for image]
Note: Earnings fifths are based on the present value of total household
lifetime earnings. Household analysis is based on per capita benefits,
taxes, and earnings. This includes all sample members who survive past
age 24 and assumes 100 percent account participation with all account
participants choosing the same portfolios--50 percent equities,
30 percent corporate bonds, and 20 percent Treasury bonds. Accounts
earn a constant real return of 4.6 percent.
[End of figure]
It should be emphasized that these simulations are only for individuals
born in 1985,[Footnote 16] and the distributional impact of Model 2
could be different for individuals born in later years. For example,
under the proposal, initial Social Security defined benefits only grow
with prices, while initial benefits from account balances grow with
wages. Since wages generally grow faster than prices, Social Security
defined benefits will decline as a proportion of total benefits,
reducing the importance of the progressive benefit formula, disability
benefits, and the enhanced benefits for low earners and survivors.
It should also be noted that the account feature of Model 2-100 percent
likely exposes recipients to greater financial risk. Greater exposure
to risk may not affect the shares of benefits received by the bottom
and top fifths of earnings.[Footnote 17] However, greater risk may be
more problematic for lower earners, who likely have fewer resources to
fall back on if their accounts perform poorly.[Footnote 18]
Conclusion:
By design, Social Security distributes benefits and contributions
across workers and their families in a variety of ways. These
distributional effects illustrate how the program balances the goal of
helping ensure adequate incomes with the goal of giving all workers a
fair deal on their contributions. Any changes to Social Security would
potentially alter those distributional effects and the balance between
those goals. Therefore, policy makers need to understand how to
evaluate distributional effects of alternative policies.
Several key themes inform this understanding. First, it should be noted
that greater benefit progressivity is not the same thing as greater
benefit adequacy. Under some reform scenarios, Social Security could
distribute benefits more progressively than under current law while
providing lower, less adequate benefits. Secondly, our analysis
illustrates that it that is possible for some reform provisions that
may not favor lower earners to be counterbalanced by other, more
favorable ones. Finally, benefit progressivity is only one of several
aspects of balancing adequacy and equity. As our framework suggests,
besides balancing adequacy and equity, a proposal's effect on the
economy and whether it achieves sustainable solvency should also be
considered, as well as how readily it could be implemented and
explained to the public.
As we have noted in the past before this committee and elsewhere, a
comprehensive evaluation is needed that considers a range of effects
together. Focusing on comprehensive packages of reforms will enable us
to foster credibility and acceptance. This will help us avoid getting
mired in the details and losing sight of important interactive effects.
It will help build the bridges necessary to achieve consensus.
The fundamental nature of the program's long-term financing challenge
means that timely action is needed. I believe it is possible to craft a
solution that will protect Social Security benefits for the nation's
current and near-term retirees, while ensuring that the system will be
there for future generations. Stated differently, I believe that it is
possible to reform Social Security in a way that will assure the
program's solvency and sustainability while exceeding the expectations
of all generations of Americans. In this regard, the sooner we act, the
greater the opportunity to achieve this desirable outcome. It is my
hope that we will think about the unprecedented challenge facing future
generations in our aging society. We need to act now before the
approaching demographic tidal wave makes the imbalances more dramatic
and meaningful reform less feasible. We at GAO look forward to
continuing to work with this Committee and the Congress in addressing
this and other important issues facing our nation. In doing so, we will
be true to our core values of accountability, integrity, and
reliability.
Mr. Chairman, and members of the Committee, that concludes my
statement. I'd be happy to answer any questions you may have.
GAO Contact and Staff Acknowledgments:
For information regarding this testimony, please contact Barbara D.
Bovbjerg, Director, Education, Workforce, and Income Security Issues,
at (202) 512-7215. Individuals making key contributions to this
testimony include Ken Stockbridge, Charles Jeszeck, and Gordon Mermin.
[End of section]
Related GAO Products:
Social Security: Distribution of Benefits and Taxes Relative to
Earnings Level (GAO-04-747, June 15, 2004).
Social Security Reform: Analysis of a Trust Fund Exhaustion Scenario
(GAO-03-907, July 29, 2003):
Social Security and Minorities: Earnings, Disability Incidence, and
Mortality Are Key Factors That Influence Taxes Paid and Benefits
Received (GAO-03-387, Apr. 23, 2003):
Social Security: Analysis of Issues and Selected Reform Proposals,
(GAO-03-376T, Jan. 15, 2003).
Social Security Reform: Analysis of Reform Models Developed by the
President's Commission to Strengthen Social Security (GAO-03-310,
Jan. 15, 2003).
Social Security: Long-Term Financing Shortfall Drives Need for Reform
(GAO-02-845T, June 19, 2002).
Social Security: Program's Role in Helping Ensure Income Adequacy
(GAO-02-62, Nov. 30, 2001).
Social Security Reform: Potential Effects on SSA's Disability Programs
and Beneficiaries (GAO-01-35, Jan. 24, 2001).
Social Security: Evaluating Reform Proposals (GAO/AIMD/HEHS-00-29,
Nov. 4, 1999).
Social Security: Issues in Comparing Rates of Return with Market
Investments (GAO/HEHS-99-110, Aug. 5, 1999).
Social Security: Criteria for Evaluating Social Security Reform
Proposals (GAO/T-HEHS-99-94, Mar. 25, 1999).
Social Security Financing: Implications of Government Stock Investing
for the Trust Fund, the Federal Budget, and the Economy (GAO/AIMD/
HEHS-98-74, Apr. 22, 1998).
FOOTNOTES
[1] Social Security refers here to the Old-Age, Survivors, and
Disability Insurance (OASDI) program.
[2] See the list of related GAO products at the end of this statement.
[3] 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.
[4] Separately, the Disability Insurance (DI) fund is projected to be
exhausted in 2029 and the Old-Age and Survivors' Insurance (OASI) fund
in 2044.
[5] If the unified budget is in surplus at this point, then financing
the excess benefits will require less debt redemption rather than
increased borrowing.
[6] GAO's health care framework can be found at www.gao.gov/cghome/
hccrisis/health.pdf. See also U.S. General Accounting Office,
Comptroller General's Forum on Health Care: Unsustainable Trends
Necessitate Comprehensive and Fundamental Reforms to Control Spending
and Improve Value, GAO-04-793SP (Washington, D. C.: May 1, 2004).
[7] 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).
[8] Testimony before the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, July 24, 2001.
[9] 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 with making changes exclusively to taxes
or benefits as shown in figure 7.
[10] U.S. General Accounting Office, Social Security: Distribution of
Benefits and Taxes Relative to Earnings Level, GAO-04-747 (Washington,
D.C.: June 15, 2004).
[11] For more details on the alternative benefit-reduction benchmarks,
see appendix I in U.S. General Accounting Office, Social Security:
Distribution of Benefits and Taxes Relative to Earnings Level,
GAO-04-747 (Washington, D.C.: June 15, 2004).
[12] The annual trustees' report uses illustrative "scaled earnings"
patterns. The values of the replacement rates for these scaled earnings
patterns at age 65 are virtually identical to the ones presented in
figure 1. See The Board of Trustees, Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds, The 2004 Annual Report
of the Board of Trustees of the Federal Old-Age and Survivors Insurance
and Disability Insurance Trust Funds (Washington, D.C.: Mar. 23, 2004).
pp. 186-187.
[13] The limit on account contributions would grow over time at the
same rate as wages.
[14] See U.S. General Accounting Office, Social Security Reform:
Analysis of Reform Models Developed by the President's Commission to
Strengthen Social Security, GAO-03-310 (Washington, D.C.: Jan. 15,
2003), p. 24.
[15] Each participant has portfolio allocation of 50 percent in
equities, 30 percent in corporate bonds, and 20 percent in U.S.
Treasury long-term bonds. All portfolios earn a constant 4.6 percent
real rate of return. For sensitivity analysis, we also simulated
scenarios with rates of return varying stochastically across
individuals and with higher and lower returns to equities. Shares of
benefits by quintiles of lifetime earnings were very similar under all
specifications.
[16] In our modeling, we focused on workers born in 1985 because all
prospective program changes under all alternative policy scenarios
would be almost fully phased in for such workers.
[17] We simulated an alternative version of Model 2-100 percent where
the return to equities varied stochastically across individuals and
over time. Shares of benefits by earnings quintile were almost
identical to the scenario that assumed constant returns to equities.
[18] Lower earners may be more risk averse than higher earners and
therefore suffer greater utility loss from increased risk.