Social Security
Long-Term Challenges Warrant Early Action
Gao ID: GAO-05-303T February 3, 2005
Social Security is the foundation of the nation's retirement income system, helping to protect the vast majority of American workers and their families from poverty in old age. However, it is much more than a retirement program and also provides millions of Americans with disability insurance and survivors' benefits. Over the long term, as the baby boom generation retires and as Americans continue to live longer and have fewer children, Social Security's financing shortfall presents a major program solvency and sustainability challenge that is growing as time passes. The Chairman and Ranking Member of the Senate Special Committee on Aging asked GAO to discuss the future of the Social Security program. This testimony will address the nature of Social Security's long-term financing problem and why it is preferable for Congress to take action sooner rather than later, as well as the broader context in which reform proposals should be considered.
Although the Social Security system in not in crisis today, it faces serious and growing solvency and sustainability challenges. Furthermore, Social Security's problems are a subset of our nation's overall fiscal challenge. Absent reform, the nation will ultimately have to choose among escalating federal deficits and debt, huge tax increases and/or dramatic budget cuts. GAO's long-term budget simulations 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. With regard to Social Security, if we did nothing until 2042, achieving actuarial balance would require a reduction in benefits of 30 percent or an increase in payroll taxes of 43 percent. In contrast, taking action soon will serve to reduce the amount of change needed to ensure that Social Security is solvent, sustainable, and secure for current and future generations. Acting sooner will also serve to improve the federal government's credibility with the markets and the confidence of the American people in the government's ability to address long-range challenges before they reach crisis proportions. However, financial stability should not be the only consideration when evaluating reform proposals. Other important objectives, such as balancing the adequacy and equity of the benefits structure need to be considered. Furthermore, any changes to Social Security should be considered in the context of the broader challenges facing our nation, such as the changing nature of the private pension system, escalating health care costs, and the need to reform Medicare and Medicaid.
GAO-05-303T, Social Security: Long-Term Challenges Warrant Early Action
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Testimony:
Before the Special Committee on Aging, U.S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 2:00 p.m. EST:
Thursday, February 3, 2005:
Social Security:
Long-Term Challenges Warrant Early Action:
Statement of David M. Walker:
Comptroller General of the United States:
GAO-05-303T:
GAO Highlights:
Highlights of GAO-05-303T, a report to the Special Committee on Aging,
U.S. Senate:
Why GAO Did This Study:
Social Security is the foundation of the nation‘s retirement income
system, helping to protect the vast majority of American workers and
their families from poverty in old age. However, it is much more than a
retirement program and also provides millions of Americans with
disability insurance and survivors‘ benefits. Over the long term, as
the baby boom generation retires and as Americans continue to live
longer and have fewer children, Social Security‘s financing shortfall
presents a major program solvency and sustainability challenge that is
growing as time passes.
The Chairman and Ranking Member of the Senate Special Committee on
Aging asked GAO to discuss the future of the Social Security program.
This testimony will address the nature of Social Security‘s long-term
financing problem and why it is preferable for Congress to take action
sooner rather than later, as well as the broader context in which
reform proposals should be considered.
What GAO Found:
Although the Social Security system in not in crisis today, it faces
serious and growing solvency and sustainability challenges.
Furthermore, Social Security‘s problems are a subset of our nation‘s
overall fiscal challenge. Absent reform, the nation will ultimately
have to choose among escalating federal deficits and debt, huge tax
increases and/or dramatic budget cuts. GAO‘s long-term budget
simulations 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. With regard to Social Security, if we
did nothing until 2042, achieving actuarial balance would require a
reduction in benefits of 30 percent or an increase in payroll taxes of
43 percent. In contrast, taking action soon will serve to reduce the
amount of change needed to ensure that Social Security is solvent,
sustainable, and secure for current and future generations. Acting
sooner will also serve to improve the federal government‘s credibility
with the markets and the confidence of the American people in the
government‘s ability to address long-range challenges before they reach
crisis proportions.
However, financial stability should not be the only consideration when
evaluating reform proposals. Other important objectives, such as
balancing the adequacy and equity of the benefits structure need to be
considered. Furthermore, any changes to Social Security should be
considered in the context of the broader challenges facing our nation,
such as the changing nature of the private pension system, escalating
health care costs, and the need to reform Medicare and Medicaid.
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. Estimates cover the
time period from January 1st of the first year to December 31, 2078.
[End of figure]
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[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 and how to address the challenges presented in
ensuring the long-term viability of this important social insurance
system. 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, the system faces
both solvency and sustainability challenges in the longer term. While
the Social Security program does not face an immediate crisis, it does
have a $3.7 trillion gap between promised and funded benefits in
current dollar terms. This gap is growing rapidly and, given this and
other major fiscal challenges, it would be prudent to act sooner rather
than later to reform the Social Security program. Failure to take steps
to address our large and structural long-range fiscal imbalance, which
is driven in large part by projected increases in Medicare, Medicaid
and Social Security spending, will ultimately have significant adverse
consequences for our future economy and quality of life.
Let me begin by highlighting a number of important points concerning
the Social Security challenge.
* 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 insurance program that
affects virtually every American family. It currently pays benefits to
more than 47 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 almost 69 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.
* 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 financial
condition of the Social Security program. For example, 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. Furthermore,
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.
* 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 Old-Age and Survivors Insurance and Disability Insurance
(OASDI) program, together with the rapidly growing health programs,
will dominate the federal government's future fiscal outlook. While
this hearing is not about the complexities of Medicare, 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. Taken together, Social Security, Medicare, and
Medicaid represent an unsustainable burden on future generations. Under
the 2004 Trustees' intermediate estimates and the Congressional Budget
Office's (CBO) long-term Medicaid estimates, spending for Social
Security, Medicare, and Medicaid combined will grow to 15.6 percent of
GDP in 2030 from today's 8.5 percent. Absent meaningful changes to
these programs, the nation will ultimately have to choose among
persistent, escalating federal deficits, huge tax increases, and/or
dramatic budget cuts. Furthermore, any changes to Social Security
should be considered in the context of the problems currently facing
our nation's private pension system. These include the chronically low
level of coverage of the private workforce, the continued decline in
defined benefit plans coupled with the termination of large underfunded
plans by bankrupt firms, and the shift by employers to defined
contribution plans, where workers face the potential for greater return
but also assume greater financial risk.
* Acting sooner rather than later helps 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 fund is exhausted in 2042. The trust fund cash
surpluses that are now helping to finance the rest of the government's
budgetary needs will begin to decline after 2008, and by 2018, the cash
surpluses will turn into deficits. At that point, Social Security's
cash shortfall will begin to 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 a further delay of the really tough decisions on Medicare
and Medicaid. Acting sooner rather than later would allow changes to be
phased in so that future and near-term retirees have time to adjust
their retirement planning. Furthermore, acting sooner rather than later
would serve to increase our credibility with the markets and improve
the public's confidence in the federal government's ability to deal
with our significant long-range fiscal challenges before they reach
crisis proportions.
* Reform proposals should be evaluated as packages. The elements of any
package interact; every package will have pluses and minuses, and no
plan will satisfy everyone on all dimensions. If we focus on the pros
and cons of each element of reform by itself, we may find it impossible
to build the bridges necessary to achieve consensus. It is also
important to establish the appropriate comparisons or benchmarks
against which reforms should be measured. Given the current projected
financial shortfall of the program, it is important to compare
proposals to at least two benchmarks--one that raises revenue to fund
currently scheduled benefits (promised benefits) and one that adjusts
to current tax financing by reducing benefits (funded benefits).
Comparing the benefit impact of reform proposals solely to currently
scheduled Social Security benefits is inappropriate since all current
scheduled benefits are not funded over the longer term. Estimating
future effects on Social Security benefits should reflect the fact that
the program faces a long-term actuarial deficit and that benefit
reduction and/or revenue increases will be necessary to restore
solvency. The key point is that there is a significant gap between
scheduled benefits and projected revenues. In fact, a primary purpose
of most Social Security reform proposals is to close or eliminate this
gap.
Failure to address the Social Security financing problem will, in
combination with other entitlement spending, constitute an
unsustainable burden on both the federal government and, ultimately,
the economy. However, this problem 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 has prevented many former workers and their families from
living their retirement years in poverty. As the Congress considers
proposals to restore the long-term financial stability and viability of
the Social Security system, it will also need to consider the impact of
the potential changes on the millions of Americans the system serves:
specifically, the effects on different types of beneficiaries and the
resulting implications for the adequacy and equity of the benefits
structure. 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 solvent, sustainable, and secure for future generations. Stated
differently, I believe that it is possible to reform Social Security in
a way that will ensure the program's solvency, sustainability, and
security while exceeding the expectations of all generations of
Americans. I also believe that, given our other fiscal challenges, it
is prudent to act sooner rather than later to address this large and
growing problem.
Social Security's Long-term Financing Problem Is More Urgent than It
May Appear:
Today, the Social Security program does not face an immediate crisis,
but it does face a long-range financing problem driven primarily by
known demographic trends that is growing rapidly. While the crisis is
not immediate, the challenge is more urgent than it may appear. Acting
soon to address these problems 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 also allow changes to be phased in so that 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." On the other hand, failure to take
remedial action will, in combination with other entitlement spending,
lead to a situation unsustainable for both the federal government and,
ultimately, the economy.
The Social Security system has required changes in the past to ensure
future solvency. Indeed, the Congress has always taken the actions
necessary to do this when faced with an immediate solvency crisis. I
would like to spend some time describing the nature, timing, and extent
of Social Security's financing problem.
The Causes of Social Security's Long-Term Financing Problem:
As you all know, Social Security has always been a largely pay-as-you-
go system. This means that the system's financial condition is directly
affected by the relative size of the populations of covered workers and
beneficiaries. Historically, this relationship has been favorable. Now,
however, people are living longer, and spending more time in
retirement. As shown in figure 1, the U.S. elderly dependency ratio is
expected to continue to increase.[Footnote 1] The proportion of the
elderly population relative to the working-age population in the U.S.
rose from 13 percent in 1950 to 19 percent in 2000. By 2050, there is
projected to be almost 1 elderly dependent for every 3 people of
working age--a ratio of 32 percent. Additionally, the average life
expectancy of males at birth has increased from 66.6 in 1960 to 74.3 in
2000, with females at birth experiencing a rise of 6.6 years from 73.1
to 79.7 over the same period. As general life expectancy has increased
in the United States, there has also been an increase in the number of
years spent in retirement. Improvements in life expectancy have
extended the average amount of time spent by workers in retirement from
11.5 years in 1950 to 18 years for the average male worker as of 2003.
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.[Footnote 2]
Today it is a little over 2, and by 2030 it is expected to fall to
1.95--a rate that is below what it takes to maintain a stable
population. Taken together, these trends threaten the financial
solvency and sustainability of this important program.
Figure 1: U.S. Elderly Dependency Ratio Expected to Continue to
Increase:
[See PDF for image]
[End of figure]
The result of these trends is that labor force growth will continue to
decline in 2006 and by 2025 is expected to be less than a fifth of what
it is today, as shown in figure 2. Relatively fewer U.S. workers will
be available to produce goods and services. Without a major increase in
productivity or increases in immigration, 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: U.S. Labor Force Growth Will Continue to Decline:
[See PDF for image]
Note: Percentage change is calculated as a centered 5-year moving
average of projections based on the intermediate assumptions of the
2004 Trustees Reports.
[End of figure]
This slowing labor force growth has important implications for the
Social Security system. 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. 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 amount
of time spent in retirement could be diminished. This could improve the
finances of Social Security and mitigate the expected slowdown in labor
force growth.
The Social Security program's situation is one symptom of this larger
demographic trend that will have broad and profound effects on our
nation's future in other ways as well. The aging of the labor force and
the reduced growth in the number of workers will have important
implications for the size and composition of the labor force, as well
as the characteristics of many jobs in our increasingly knowledge-based
economy, throughout the 21st century. The U.S. workforce of the 21st
century will be facing very different opportunities and challenges than
those of previous generations.
Cash Flow Turns Negative in 2018:
Today, the Social Security Trust Funds take in more in taxes than they
spend. Largely because of the 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, program spending will constitute a rapidly growing
share of the budget and the economy well before that date. 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 to decline in 2008. By 2018, the
program's cash flow is projected to turn negative--its tax income will
fall below benefit payments. At that time, the program will begin to
experience a negative cash flow, which will accelerate over time.
Social Security will join Medicare's Hospital Insurance Trust Fund,
whose outlays exceeded cash income in 2004, as a net claimant on the
rest of the federal budget. (See figure 3.)
Figure 3: Social Security and Medicare's Hospital Insurance Trust Funds
Face Cash Deficits:
[See PDF for image]
[End of figure]
In 2018, the combined OASDI Trust Funds will begin drawing on its
Treasury securities to cover the cash shortfall. At this point,
Treasury will need to obtain cash for these redeemed securities either
through increased taxes, spending cuts, and/or more borrowing from the
public than would have been the case had Social Security's cash flow
remained positive. Whatever the means of financing, the 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.
Different Measures but Same Challenges and Same Conclusion:
There are different ways to describe the magnitude of the problem. A
case can be made for a range of different measures, as well as
different time horizons. For instance, the actuarial deficit can be
measured in present value, as a percentage of GDP, or as a percentage
of taxable payroll in the future. The Social Security Administration
(SSA) and CBO have both made projections of Social Security's future
actuarial deficit using different horizons. (See table 1.)
Table 1: Different Measures, Same Challenge:
Projection horizon: 75 year (SSA);
Projections of actuarial deficit in terms of present value: $3.7
Trillion;
Projections of actuarial deficit in terms of percent of GDP: 0.7%;
Projections of actuarial deficit in terms of percent of payroll: 1.89%.
Projection horizon: 100 year (CBO);
Projections of actuarial deficit in terms of present value: $4.6
Trillion;
Projections of actuarial deficit in terms of percent of GDP: 0.54%;
Projections of actuarial deficit in terms of percent of payroll: 1.44%.
Projection horizon: Infinite horizon (SSA);
Projections of actuarial deficit in terms of present value: $10.4
Trillion;
Projections of actuarial deficit in terms of percent of GDP: 1.2%;
Projections of actuarial deficit in terms of percent of payroll: 3.5%.
Sources: Social Security Administration, 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., March 2004.
Congressional Budget Office, The Outlook for Social Security: Potential
Range of Social Security Outlays and Revenues Under Current Law.
Washington, D.C., June 2004.
[End of table]
CBO uses a 100-year horizon to project Social Security's future
actuarial deficit, while the Social Security Administration utilizes
both 75-year and infinite horizon projections to estimate the future
deficit. In addition, both the Social Security Administration and CBO
have different economic assumptions for variables such as real
earnings, real interest rates, inflation, and unemployment.
While their estimates vary due to different horizons and economic
assumptions, each identifies the same long-term challenge: The Social
Security system is unsustainable in its present form over the long run.
Taking action soon on Social Security would not only make the necessary
action less dramatic than if we wait but would also promote increased
budgetary flexibility in the future and stronger economic growth. Some
of the benefits of early action--and the costs of delay--can be seen in
figure 4. This figure compares what it would take to keep Social
Security solvent through 2078, if action were taken at three different
points in time, by either raising payroll taxes or reducing benefits.
If we did nothing until 2042--the year SSA estimates the Trust Funds
will be exhausted--achieving actuarial balance would require changes in
benefits of 30 percent or changes in taxes of 43 percent. As figure 4
shows, earlier action shrinks the size of the necessary adjustment.
Figure 4: 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]
Social Security Reform Is Part of a Broader Fiscal and Economic
Challenge:
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 Americans in the
future. Reforming Social Security and health programs is essential to
reclaiming our future fiscal flexibility to address other national
priorities.
Changes in the composition of federal spending over the past several
decades have reduced budgetary flexibility, and our current fiscal path
will reduce it even further. During this time, 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.
If you look ahead in the federal budget, the Social Security programs
(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 among persistent, escalating
federal deficits and debt, huge tax increases and/or dramatic budget
cuts. GAO's long-term budget simulations 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
that discretionary spending grows with inflation and all existing tax
cuts are allowed to expire when scheduled under current law, spending
for Social Security and health care programs would grow to consume over
three-quarters of federal revenue by 2040. Moreover, if all expiring
tax provisions are extended and discretionary spending keeps pace with
the economy, by 2040 total federal revenues may be adequate to pay
little more than interest on the federal debt. (See figure 5.)
Figure 5: Composition of Spending as a Share of GDP:
[See PDF for image]
Notes: 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 AMT, and (3) increased revenue
from tax-deferred retirement accounts. After 2014, revenue as a share
of GDP is held constant.
[End of figure]
Alternatively, 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. 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 3] 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.
Also, at the same time it is important to look beyond the federal
budget to the economy as a whole. Under the 2004 Trustees' intermediate
estimates and CBO's long-term Medicaid estimates, spending for Social
Security, Medicare, and Medicaid combined will grow to 15.6 percent of
GDP in 2030 from today's 8.5 percent (See figure 6.) 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: Social Security and Medicare projections based on the
intermediate assumptions of the 2004 Trustees' Reports. Medicaid
projected based on CBO's January 2004 short-term Medicaid estimates and
CBO's December 2003 long-term Medicaid projections under mid-range
assumptions.
[End of figure]
Considerations in Assessing Reform Options:
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. In 2004, Social Security paid almost
$493 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 GAO Criteria for Reform:
The analytic framework GAO has developed to assess proposals comprises
three basic criteria:
* Financing Sustainable Solvency--the extent to which a proposal
achieves sustainable solvency and how it would affect the economy and
the federal budget. Our sustainable solvency standard encompasses
several different ways of looking at the Social Security program's
financing needs. While a 75-year actuarial balance has generally been
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.
* Balancing Adequacy and Equity--the relative balance struck between
the goals of individual equity and income adequacy. 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, Social Security 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.
* Implementing and Administering Proposed Reforms--how readily a
proposal could be implemented, administered, and explained to the
public. 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. Although these issues may
appear technical or routine on the surface, they are important issues
because they have the potential to delay--if not derail--reform if they
are not considered early enough for planning purposes. Moreover, issues
such as feasibility and cost can, and should, influence policy choices.
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.
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. 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.
One issue that often arises within the Social Security debate concerns
the appropriate comparisons or benchmarks to be used when assessing a
particular proposal. While this issue may seem to be somewhat abstract,
it has critical implications, for depending on the comparisons chosen,
a proposal can be made more or less attractive. Some analyses compare
proposals to a single benchmark and as a result can lead to incomplete
or misleading conclusions. For that reason, GAO has used several
benchmarks in assessing reform proposals.[Footnote 4] Currently
promised benefits are not fully financed, and so any analysis that
seeks to fairly evaluate reform proposals should rely on benchmarks
that reflect a policy of an adequately financed system. Similarly, it
is important to have benchmarks that are consistent with each other.
Using one that relies on action relatively soon versus one that posits
no action at all are not consistent and could also lead to misleading
conclusions. Estimating future effects on Social Security benefits
should reflect the fact that the program faces a long-term actuarial
deficit and that conscious policies of benefit reduction and/or revenue
increases will be necessary to restore solvency and sustain it over
time.
Reform Will Have Pervasive Impact on the Social Security Program:
A variety of proposals have been offered to address Social Security's
financial problems. Many proposals contain reforms that would alter
benefits or revenues within the structure of the current defined
benefits system. Some would reduce benefits by modifying the benefit
formula (such as increasing the number of years used to calculate
benefits or using price-indexing instead of wage-indexing), reduce
cost-of-living adjustments (COLA), raise the normal and/or early
retirement ages, or revise dependent benefits. Some of the proposals
also include measures or benefit changes that seek to strengthen
progressivity (e.g., replacement rates) in an effort to mitigate the
effect on low-income workers. Others have proposed revenue increases,
including raising the payroll tax or expanding the Social Security
taxable wage base that finances the system; increasing the taxation of
benefits; or covering those few remaining workers not currently
required to participate in Social Security, such as older state and
local government employees.
A number of proposals also seek to restructure the program through the
creation of individual accounts. Under a system of individual accounts,
workers would manage a portion of their own Social Security
contributions to varying degrees. This would expose workers to a
greater degree of risk in return for both greater individual choice in
retirement investments and the possibility of a higher rate of return
on contributions than available under current law. There are many
different ways that an individual account system could be set up. For
example, contributions to individual accounts could be mandatory or
they could be voluntary. Proposals also differ in the manner in which
accounts would be financed, the extent of choice and flexibility
concerning investment options, the way in which benefits are paid out,
and the way the accounts would interact with the existing Social
Security program--individual accounts could serve either as an addition
to or as a replacement for part of the current benefit structure.
In addition, the timing and impact of individual accounts on the
solvency, sustainability, adequacy, equity, net savings, and rate of
return associated with the Social Security system varies depending on
the structure of the total reform package. Individual accounts by
themselves will not lead the system to sustainable solvency. Achieving
sustainable solvency requires more revenue, lower benefits, or both.
Furthermore, incorporating a system of individual accounts may involve
significant transition costs. These costs come about because the Social
Security system would have to continue paying out benefits to current
and near-term retirees concurrently with establishing new individual
accounts.
Individual accounts can contribute to sustainability as they could
provide a mechanism to prefund retirement benefits that would be immune
to demographic booms and busts. However, if such accounts are funded
through borrowing, no such prefunding is achieved. An additional
important consideration in adopting a reform package that contains
individual accounts would be the level of benefit adequacy achieved by
the reform. To the extent that benefits are not adequate, it may result
in the government eventually providing additional revenues to make up
the difference.
Also, some degree of implementation and administrative complexity
arises in virtually all proposed changes to Social Security. 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. The Federal Thrift Savings Plan (TSP) could
serve as a model for providing a limited amount of options that reduce
risk and administrative costs while still providing some degree of
choice. However, a system of accounts that spans the entire national
workforce and millions of employers would be significantly larger and
more complex than the TSP or any other system we have in place today.
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.
Social Security Reform Should Be Considered in the Context of Broader
Challenges:
Another important consideration for Social Security reform is assessing
a proposal's effect on national saving. Individual account proposals
that fund accounts through redirection of payroll taxes or general
revenue do not increase national saving on a first order basis. The
redirection of payroll taxes or general revenue reduces government
saving by the same amount that the individual accounts increase private
saving. Beyond these first order effects, the actual net effect of a
proposal on national saving is difficult to estimate due to
uncertainties in predicting changes in future spending and revenue
policies of the government as well as changes in the saving behavior of
private households and individuals. For example, the lower surpluses
and higher deficits that result from redirecting payroll taxes to
individual accounts could lead to changes in federal fiscal policy that
would increase national saving. On the other hand, households may
respond by reducing their other saving in response to the creation of
individual accounts. No expert consensus exists on how Social Security
reform proposals would affect the saving behavior of private households
and businesses.
Finally, the effort to reform Social Security is occurring as our
nation's private pension system is also facing serious challenges. Only
about half of the private sector workforce is covered by a pension
plan. A number of large underfunded traditional defined benefit plans-
-plans where the employer bears the risk of investment--have been
terminated by bankrupt firms, including household names like Bethlehem
Steel, US Airways, and Polaroid. These terminations have resulted in
thousands of workers losing promised benefits and have saddled the
Pension Benefit Guaranty Corporation, the government corporation that
partially insures certain defined benefit pension benefits, with
billions of dollars in liabilities that threaten its long-term
solvency. Meanwhile, the number of traditional defined benefit pension
plans continues to decline as employers increasingly offer workers
defined contribution plans like 401(k) plans where, like individual
accounts, workers face the potential of both greater return and greater
risk. These challenges serve to reinforce the imperative to place
Social Security on a sound financial footing.
Regardless of what type of Social Security reform package is adopted,
continued confidence in the Social Security program is essential. 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.
Conclusions:
Social Security does not face an immediate crisis but it does face a
large and growing financial problem. In addition, our Social Security
challenge is only part of a much broader challenge that includes, among
other things, the need to reform Medicare, Medicaid and our overall
health care system.
Today many retirees and near retirees fear cuts that would affect them
in the immediate future while young people believe they will get little
or no Social Security benefits in the longer term. I believe that it is
possible to reform Social Security in a way that will ensure the
program's solvency, sustainability, and security while exceeding the
expectations of all generations of Americans.
In my view, there is a window of opportunity to reform Social Security;
however, this window of opportunity will begin to close as the baby
boom generation begins to retire. Furthermore, it would be prudent to
move forward to address Social Security now because we have much larger
challenges confronting us that will take years to resolve. The fact is,
compared to addressing our long-range health care financing problem,
reforming Social Security should be easy lifting.
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.
FOOTNOTES
[1] The elderly dependency ratio is the ratio of the population aged 65
years or over to the population aged 15 to 64.
[2] The fertility rate is the average number of children a hypothetical
cohort of women would have at the end of their reproductive period if
they were subject during their whole lives to the fertility rates of a
given period and if they were not subject to mortality. It is expressed
as children per woman.
[3] GAO, Fiscal Exposures: Improving the Budgetary Focus on Long-Term
Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan 24, 2003).
[4] GAO, 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).