SOCIAL SECURITY'S FUTURE
COMMITTEE ON WAYS AND MEANS
SOCIAL SECURITY SUBCOMMITTEE
JANUARY 26, 2004 BOCA RATON, FLORIDA
JAMES B. LOCKHART, III DEPUTY COMMISSIONER
OF SOCIAL SECURITY
Chairman Shaw, Members of the Social Security Subcommittee, thank you for inviting me to Florida Atlantic University today to discuss the important issue of strengthening Social Security. I would like to take this opportunity to commend the Chairman for holding this hearing, and keeping this vitally important issue before the public. It's always a pleasure to get outside the Washington Beltway to discuss this issue, as it is one that affects all Americans, all around the country. President Bush and we at Social Security think strengthening Social Security is a critical issue and Commissioner Jo Anne Barnhart has made achieving sustainable solvency one of Social Security's four major strategic goals.
I would like to begin by discussing the current status of the Social Security program and how it works. Then I will address the financial challenges Social Security will face in the future. The numbers I will cite come directly from the 2003 Annual Report of Social Security's Board of Trustees.
Today, Social Security is running surpluses, but the Social Security program as currently financed is unsustainable over the long term. I must emphasize, as President Bush has repeatedly, that the benefits promised to current retirees and those nearing retirement are safe. Changes proposed to address Social Security's future financing shortfalls will not result in benefit reductions for retirees or near- retirees.
Social Security touches the lives of nearly everyone in America by paying benefits, issuing Social Security cards, and recording tax and earnings records. That is why the Social Security Act was recently voted in a poll conducted by the National Archives as one of the top 10 documents in American history, sharing that distinction with the Declaration of Independence and the Constitution among others. The Social Security Act and the Civil Rights Act were the only two pieces of legislation selected.
Social Security continues to be one of the most successful government programs. (Chart 1 ) Last year SSA paid over $450 billion in benefits to 47 million retirees, survivors, and disabled individuals and their dependents. Social Security is much more than a retirement program. Thirty percent of our beneficiaries are disabled or survivors -- widows, widowers and children. Nearly 157 million American workers paid Social Security taxes last year. They, their families, and the millions joining the system every year, are relying on Social Security for a major portion of their future financial security.
Social Security is essentially a "pay-as-you-go" system with today's payroll taxes paying today's benefits. (Chart 2 ) The combined employee and employer payroll tax is 12.4 percent on earnings up to $87,900 in this year. Over the years, the Social Security payroll tax rate has been increased 19 times. According to the Congressional Budget Office, 80 percent of workers are paying more in combined employee and employer payroll taxes than in income taxes.
Benefits have also changed over the years. (Chart 3 ) Just last year, due to a reform enacted 20 years ago, the normal retirement age is gradually starting to increase to eventually age 67. This year the age to collect full benefits is 65 years and 4 months. People can still collect Social Security retirement benefits as early as age 62, but the reduction will be greater as the normal retirement age increases.
Using the highest 35 years of earnings, the program has been designed to protect lower income workers such that their wage replacement rate is approximately 56 percent versus only 30 percent for a maximum wage earner.
Those lower wage-earner retirees are very reliant on Social Security benefits in retirement. As Chart 4 shows, the bottom quintile of retirees rely on Social Security and our means-tested Supplemental Security Income (SSI) program for 92 percent of their income while the middle quintile receive 68 percent from Social Security and SSI. And of course, Social Security is an extremely important source of income for over 14 million disabled workers and survivors.
The combined old age and disability trust funds are growing because payroll and income taxes paid on benefits currently exceed benefit payments. (Chart 5 ) Historically, the excess of taxes less benefit payments and small administrative payments is invested in special issue Treasury bonds, making the money available for other current government needs. In 2002 the funds grew to $1.4 trillion-an increase of 14 percent over the prior year. It should be noted, however, that half of that growth was from bonds issued to the fund to pay interest on existing assets.
For many years, the Trustees have stated that Social Security is unsustainable at scheduled benefit and tax rates. (Chart 6 ) They point out that pressure on the program's finances will begin in 2008, when the first baby boomers reach early retirement age and Social Security tax surpluses begin to decline. Beginning in 2018 the program is projected to begin paying out more in benefits than is collected in taxes. At that time the program will begin redeeming trust fund assets, consisting of government bonds, which will be repaid using Federal funds. By 2042, it is projected that all of the Treasury bonds that make up the trust fund assets will have been cashed in, and the Social Security trust fund assets will be exhausted.
The trust funds would need an additional $3.5 trillion today to be able to pay all scheduled benefits for the next 75 years. That means that, in addition to current Trust Fund assets, a lump sum of $3.5 trillion today, earning interest at the Treasury bond rate, would be sufficient to meet annual revenue shortfalls over the next 75 years. This $3.5 trillion is a figure roughly equal to the total public portion of the national debt. This measure of unfunded benefit obligations increased $200 billion in just one year. Absent any action to address this situation, this steady growth in the shortfall will continue, year after year.
Traditionally, the Trustees have measured the long-term financial health of the Social Security system by evaluating the system's operations over a 75-year period. However, the goal of strengthening Social Security is not simply to make the Social Security program solvent through 75 years but rather to achieve sustainable solvency, that is, to maintain solvency beyond the 75-year period and make Social Security permanently solvent. For this reason, the 2003 Trustees Report included a measure of the program's funding shortfall over the infinite horizon. Absent any benefit or tax changes, adding $10.5 trillion to the trust fund today would achieve sustainable solvency. This is the equivalent of almost $100,000 for each American family today. Without action the shortfall will continue to grow at a compounding rate.
The reason Social Security is unsustainable under current law is very simple - the aging of America. (Chart 7 ) People are living longer, the birth rate is low and the first baby boomers will be eligible to retire in 4 years. This combination means that the growth rate of retirees will begin to greatly exceed the growth of workers. As the chart shows, it is a looming iceberg.
The ratio of workers to beneficiaries has fallen from 8 to 1 in 1955 to 3.3 today. (Chart 8 ) In less than 15 years the ratio will fall to the unsustainable level of 2.9, at which time taxes received will be less than benefits payable.
Last year the General Accounting Office (GAO), at the request of the Congress, issued a report on what would happen to the Social Security program when the trust funds became exhausted. As both the GAO report and the Trustees' Annual Report show, in 2042 scheduled benefits would be cut by 27 percent. (Chart 9 ) That means anyone born in 1975 and thereafter, including my two children, will never have a year of full benefits as promised under current law.
In today's dollars, that would mean a reduction of over $600 per month or $7,500 a year for a married couple. Even many of the later baby boomers will have many years of reduced benefits. By the end of the 75-year period, the benefit reduction would be 35 percent. As the Comptroller General of the U.S. has testified, the study "dramatically illustrates the need for action sooner rather than later."
The Trustees said in their Annual Report, "The sooner adjustments are made, the smaller and less abrupt they will have to be." Changes can be phased in more gradually and spread over generations, reducing the need for any sudden and severe impact on American workers and their families. For example, the changes enacted to increase the retirement age in 1983 started last year -- 20 years later -- and were phased in over several decades.
Early action will also allow current workers plenty of time to properly plan for their retirement. And finally, the sooner action is taken, the sooner confidence can be restored to the Social Security program.
Reform alternatives are very well known as follows: (Chart 10 )
- Payroll tax increases have been the traditional reform. Over the last 50 years they have grown almost eight-fold in today's dollars for the average earner and over 14-fold for the maximum earner.
- Benefit reductions have been rarer although the increase in the retirement age is effectively a reduction in the growth of benefits. Again, I want to emphasize that the President's first principle is that any changes to the benefit structure will not affect today's retirees or near-retirees.
- A newer and more creative solution is to set aside money today to prefund future benefits and to increase the rate of return on Social Security funds. This can be done either by direct government investment in corporate stocks and bonds or by allowing individual Americans to invest in personal accounts The President has expressed his support for voluntary personal accounts, and opposes government investment of the Trust Fund in the stock market. Proponents suggest that moving Social Security partially toward a funded rather than a pay-as- you-go program can reduce the burden on future generations of workers and increase the benefits Social Security can afford to pay.
Turning to tax increases, to pay scheduled benefits over the next 75 years the combined Social Security tax would have to increase from today's 12.4 percent to almost 17 percent in 2042 and to 18.9 percent by 2077. (Chart 11 ) That is over a 50 percent increase in taxes, which would have a very negative impact on American workers and their families, on savings, and on the whole US economy.
Clearly, achieving sustainable solvency will be no easy task. However, delay only makes the task more difficult. (Chart 12 ) Solely as an illustration of the costs involved to reach solvency just through 2077, there would need to be either an immediate 15 percent increase in payroll taxes or a 13 percent reduction in benefits. If we wait until 2018, there would need to be a 22 percent increase in payroll taxes or a 16 percent reduction in benefits. And if we wait until the trust funds are exhausted in 2042, if nothing is done, payroll taxes would have to be increased by 46 percent, or benefits cut by nearly one-third.
The unattractiveness of relying exclusively on tax increases and benefit reductions to bring Social Security to balance, has led Republicans and Democrats to look for additional options. Mr. Chairman, this includes your own thoughtful proposal, the Social Security Guarantee Act of 2003. Your proposal and many other proposals, including those of President Bush's Commission to Strengthen Social Security, would establish personal accounts within Social Security. Combined with other changes personal accounts can help lead to a permanently sustainable Social Security system.
Personal accounts for younger generations could help most workers receive much higher total retirement benefits than are presently payable. The accounts, which allow more personal choice and control, would be inheritable in many of these proposals. They also would raise the private savings rate.
Opponents of personal accounts cite the volatility of stock market returns as a major negative. However, with regular investing proponents point out that over the long term, balanced, diversified funds have done better than Treasury bonds even at the bottom of the last bear market, and certainly after last year's recovery. Absent changes, scheduled benefits under the current program would have to be reduced 27 percent by 2042.
The other counter argument is that the required "seed" financing from general revenue that many personal account proposals require is not affordable. If we do not reform Social Security, as I have noted, $10.5 trillion in present-value dollars would be needed to enable the current program to pay scheduled benefits indefinitely. By setting aside money today in personal retirement accounts the expected cost to the taxpayer of paying scheduled benefits could be considerably reduced.
Most proposals analyzed by SSA's actuaries containing personal accounts would significantly reduce the long term cost of paying benefits. Each of these proposals contains its own balance between additional funding and the amount of benefits paid to future retirees. Families throughout America face a similar choice: how much can they afford to put aside in savings towards their own retirement? The more they put aside now, the less they will need to produce later; the same is true for our Social Security system.
Truly, "a stitch in time could save nine." As President Bush has said, "We will not deny, we will not ignore, we will not pass along our problems to other Congresses, to other presidents and other generations. We will confront them with focus and clarity and courage."
In March 2003, Social Security's Board of Trustees presented its annual report to President Bush personally. At this meeting, the President reiterated his support for action to strengthen Social Security, saying: (Chart 13 )
"...the Trustees confirmed that benefits for today's seniors are safe and secure. Promises made can and will be kept. The Trustees also once again have delivered a sobering message-Social Security, in its present form, is unsustainable for the long term. I share the Trustees' view that we need to explore new ways to ensure that Social Security remains strong and financially secure for America's children and grandchildren.
"I am encouraged by the unprecedented level of bipartisan interest in Social Security modernization. Many comprehensive proposals have been put forward to strengthen Social Security for the long term. Although these proposals differ in details, they are consistent in showing that if we give workers the opportunity to invest a portion of their wages in personal accounts, Social Security will be able to offer higher benefits than would otherwise be the case.
"...I hope that Members of Congress will join with the Social Security Administration and other interested parties in a national dialogue about how best to strengthen and protect Social Security. I look forward to working with Congress to see that Social Security remains sound and strong for today's and tomorrow's retirees."
This hearing, I hope, will be part of that process of working together to fulfill our obligations to the Social Security program and the hundreds of millions of Americans it serves, today and in the future. The Social Security Administration will continue to work with this subcommittee, other Members of Congress and outside groups to build this national dialogue into a bipartisan consensus on how to strengthen Social Security for future generations.
There is no other Federal program that touches the lives of so many Americans. And as important as the program is today, it will become even more important in the next few decades, when today's boomers become tomorrow's aged. Since 1935, America has found a way to provide financial security for its older citizens and, since 1957, for the disabled. We can and must find the way to do so in the future without unduly burdening succeeding generations.
In conclusion, I would like to just quote the old seafaring wisdom that I found applicable in my Navy days, which is "the world isn't interested in the storms you encountered, but whether or not you brought in the ship." We can sail straight into that perfect storm or we can change course. The sooner we change course, the smaller the changes will be and the sooner we can remove the uncertainties about Social Security's future.
I believe that this will be the true test of our own work. Storms of controversy often surround the issue of how to provide retirement security. As we look at those here today we can be proud that Social Security is here for today's seniors and redouble our commitment to ensure that Social Security will also be there for their children and grandchildren -- today's students.
Mr. Chairman, I again commend you for holding this hearing and for your efforts in keeping this issue before the public and, especially, for your very strong leadership in the bipartisan effort to strengthen Social Security. I will be happy to answer any questions you or the other Members have.