FROM THE OFFICE OF PUBLIC AFFAIRS
March 25, 2005
JS-2335
Assistant Treasury Secretary Mark Warshawsky's
Remarks to the American Enterprise Institute
on the Urgent Need for Social Security Reform
Thank you for the kind introduction. It's both an honor and a pleasure to be speaking here at the American Enterprise Institute, which is so well known and highly regarded for its careful and thoughtful analysis of public policy issues.
This morning, I'm sure Mark McClellan, Rick Foster and Steve Goss did able jobs of bringing you up to date on the financial outlooks for Medicare and Social Security as documented in the latest Trustees' Reports. So my remarks today will cover different ground. I will begin by giving praise to the process that generates the reports. I will then turn to my main topic--why it is important that responsible Social Security reform occur now, and why one element of a successful reform plan must be personal retirement accounts. Finally, I will say a few words about Medicare.
The Process Generating the Trustees' Reports
As evidenced by this conference, the Trustees' Reports get a lot of attention and are extremely influential. And well they should in my opinion! The reports have consistently provided a wealth of information in a clear and impartial format. No doubt many of the numbers in this year's Social Security report will be commonly referenced in the ongoing reform debate; for example, 2017 as the first year with negative projected cash-flows, 2041 as the year of trust fund exhaustion, $4.0 trillion as the 75-year unfunded obligation, and $11.1 trillion as the infinite horizon unfunded obligation.
My experience tells me that four important factors underlie the credibility and objectivity of the Trustees Reports. First is the composition of the Board of Trustees, which since 1984 includes two members from the private sector, the so-called "public" members, in addition to the four ex-officio members. The public members, who cannot both be from the same political party, have served the purpose espoused by the 1983 Greenspan Commission, which is to increase the public "confidence in the integrity of the trust funds." Since 1984 the Boards have had four sets of public trustees, including the most recent members Professors Tom Saving and John Palmer. All have served admirably.
The second factor contributing to the integrity of the Trustees' reports is the periodic review by external experts of the methods and assumptions underlying the projections. These reviews result in widely disseminated reports. Most recently, the assumptions and methods underlying the 2004 Medicare report and the 2003 Social Security report were reviewed by separate technical panels. Both Panels made important contributions: For example, the Social Security Panel ratified the Trustees' decision to include in the Trustee Report the infinite-horizon unfunded obligation estimates and uncertainty estimates based on stochastic simulations and the Medicare Panel endorsed the Medicare actuaries' methods for projecting prescription drug benefit costs.
The third factor contributing to the integrity of the Trustees' reports are the Actuaries' opinions at the end of the Reports. The Actuaries have fully endorsed the assumptions and methods underlying the projections.
The fourth and final factor contributing to the integrity of the Trustees' reports is a recent innovation to the report-generating process of which I am especially proud. Preparation of the Trustees reports is now a year-round effort, involving professionals from each of the interested agencies that bring to the table an enormous amount of knowledge and experience. Each year, starting soon after the spring Trustees' meeting, the Trustees' staffs along with the Actuaries and the Public Trustees examine ways to improve both the presentation and the substance of the reports. This is a top-to-bottom evaluation that ranges from potential language changes in the reports to background studies of the economic and demographic underpinnings of the projections. Agreed-upon improvements are recommended to the Board at the fall meeting. I am especially heartened at the deep involvement in this process of the Public Trustees, the Actuaries, and their respective staffs.
As a result of these annual reviews, several substantive additions have been made to the reports in the past couple of years. Among these additions are an appendix to the Social Security report presenting stochastic simulations of trust fund projections, an appendix to the Medicare report describing the relationship between the trust funds and the federal budget (a detailed version can be found on Treasury's website), and, in both reports, estimates of unfunded obligations over the infinite horizon. A large number of presentational improvements have also been made. With some justification, we could add the words "New and Improved" to the title page of each annual report.
SOCIAL SECURITY REFORM
Now, let me turn to my main topic, Social Security reform. As you are aware, President Bush has made Social Security reform a major priority of his second term. Today I'll explain why it is so important that responsible Social Security reform occur now, and why one element of a successful reform plan must be personal retirement accounts that give individuals more control over their financial futures.
The Size of Social Security's Financial Shortfall
How big is Social Security's current funding gap? The most widely cited measure of that gap is the 75-year actuarial imbalance, which is now estimated at $4.3 trillion or 1.92 percent of taxable payroll. This measure suggests that immediately raising the payroll tax rate by 1.92 percentage points, to 14.32 percent, would fix Social Security. But as many of you are aware, that is not true. If the payroll tax rate was raised in that manner, a large Trust Fund balance would be accumulated in the short-term that would peak in about 2060, and would then commence a steady decline to complete exhaustion at the end of the 75-year projection period. This type of reform would therefore not make the system permanently solvent. With each passing year, the Trustees would report an ever larger financial imbalance as the 75-year scoring window is moved forward to include years with ever larger gaps between expected system costs and income.
As this example makes clear, estimates made over a 75 year horizon do not fully capture the financial status of the Social Security program. In fact, no finite forecast period completely embodies the financial status of the program because people pay taxes in advance of receiving benefits; at any finite cutoff date, people will have accrued benefits that have not yet been paid. For example, the current 75 year projections include nearly all of the 2010 birth cohort's taxes but virtually none of their benefits. In order to get a complete picture of Social Security's permanent financial problem, the time horizon for calculating income and costs must be extended to the indefinite future. Such a calculation is provided in the 2005 Trustees Report; it is estimated there that for the entire past and future of the program, the present value of scheduled benefits exceeds the present value of scheduled tax income by $11.1 trillion. This is the financing gap that program reforms must ultimately close. To put this in perspective, eliminating the permanent deficit could be accomplished with an immediate and permanent 3.5 percentage point increase in the payroll tax rate (to 15.9 percent), or with a 22 percent reduction in all current and future benefits. In both cases, there would be massive near-term Trust Fund accumulations.
The Administration insists that reform make Social Security permanently solvent. 75-year solvency is not sufficient. The permanent solvency goal was recently unanimously endorsed by the Senate in an amendment to the Senate Budget Resolution. That amendment states that "the American people including seniors, workers, women, minorities, and disabled persons should work together at the earliest opportunity to enact legislation to achieve a solvent and permanently sustainable Social Security system."
Intergenerational Equity: Why Social Security Must be Reformed Now
It is clear that the Social Security system is not financially viable and must be fixed. How to close the permanent financing gap raises difficult questions over how the net benefits of Social Security should be shared across generations. In this context, it is important to recognize that the large unfunded obligations in the system are primarily the consequence of the past system generosity to generations that are now either dead or retired. Of course, those early generations are beyond reform's reach, so the entitlement reforms needed to close the financing gap must fall entirely on later generations.
Viewing Social Security from the perspective of how it affects generations and individuals explains why it is imperative that Social Security be reformed now. Delaying reform only reduces the options for fairly distributing the benefits of Social Security across generations. Most people agree that it would not be fair to alter Social Security's promises to retirees and near retirees. The longer reform is delayed, the fewer generations that are left to participate in a reformed entitlement system so as to close Social Security's funding gap, and the more severe those reforms will be.
To make this point more concretely, consider a policy of closing Social Security's permanent financing gap by immediately increasing the payroll tax rate by 3.5 percentage points. If the tax increase were instead delayed until 2041 when the trust fund is depleted, the requisite tax increase would be 6.3 percentage points. Clearly, I do not advocate any of these policies. My point is that there is no doubt that fairness to future generations requires that action be taken now.
I would also point out that purely pay-as-you go financing of Social Security would be grossly unfair to future generations. For example, one way to make Social Security solvent would be to leave benefits unchanged and to raise payroll taxes year by year beginning when the Trust Fund is exhausted. According to current projections, the payroll tax rate under that policy would steadily rise beginning in 2041 and reach 19 percent at the end of the 75-year projection period. No reasonable person would view that as a fair policy. I conclude that any reform that is fair would at least partially pre-fund Social Security benefits.
Fixing the System
Fortunately, the current untenable situation of Social Security is fixable. President Bush has said that "Social Security is one of the greatest achievements of the American government, and one of the deepest commitments to the American people." The President supports social security reform that increases the power of the individual, does not increase the tax burden, and provides economic opportunity for more Americans. The President has issued guiding principles for reforming Social Security.
One very important principle is that the benefits of seniors at or near retirement should be protected, and that payroll taxes should not be increased.
Another principle is that personal retirement accounts (PRAs) should be made available for younger workers to build a nest egg for retirement that they own and control, and which they can pass on to their children and grandchildren.
Additionally, we must pursue the goal of a permanently sustainable system, eschewing halfway measures that would necessitate further reforms in the future.
Personal Retirement Accounts
I would like to focus on the advantages of PRAs. PRAs provide individual control, ownership, and offer individuals the opportunity to partake in the benefits of investing in private-sector markets. Individual control and ownership means that people would be free to pass the value of accounts to their heirs (bequests).
Personal retirement accounts will be voluntary. At any time a worker can "opt in" by making a one-time election to put a portion of his or her payroll taxes into a personal retirement account. A worker who chooses not to opt in will receive traditional Social Security benefits, reformed so as to make the system permanently solvent.
Perhaps most importantly, the retirement security of our current young and future workers depends on PRAs. PRAs allow individuals to save now to help fund their retirement incomes. In principle, that could be done with reforms that save tax revenues in the Social Security Trust Fund. But such "saving" would almost certainly be undone by political pressures to increase government spending and hence produce larger deficits outside of Social Security. The only way to truly save for our retirement and give our children and grandchildren a fair deal is with personal accounts. Personal accounts serve as private and therefore effective "lock boxes". When pre-funding is done using a personal account, there is no pressure to increase government spending, because this pre-funding belongs to individuals and does not appear on the government balance sheet as budget surpluses.
MEDICARE
Some have questioned the policy focus on Social Security when the financial shortfalls facing Medicare are so much larger than those facing Social Security. One reason is simply that much more analytical groundwork needs to be done and experience gathered before we as a society can begin to coalesce around options that completely address the unsustainable growth in Medicare and other health care expenditures. The same is not true of Social Security. Ever since the release of the 1994-96 Social Security Advisory Council report, the research and policy communities here in Washington and elsewhere have put a tremendous amount of thought and effort into exhaustively identifying and analyzing the possibilities for effective Social Security reform. Unlike with Medicare, we know our options very well.
But I assure you that the Administration is aware of the important issues with Medicare's finances, and, as I'll point out, has already begun to lay the necessary policy groundwork.
Medicare finances are projected to get out of hand not only because of an aging society, but more importantly because of rapidly increasing health care costs. High health cost growth is not a Medicare-specific problem, but an economy-wide problem. The same projections that show the Medicare program consuming 13.5 percent of GDP in 2079 also show health care consuming well over 40 percent of GDP that same year. So, efforts to confront unsustainable trends in Medicare expenditure growth must coincide with efforts to deal with unsustainable economy-wide health expenditure growth.
Indeed, the Administration has promoted incremental policies to make health care choices better informed and more responsive to costs and benefits. Several such policies were included in the Medicare Modernization Act (MMA). To promote consumer cost-consciousness, the MMA introduced health savings accounts, or HSAs, to the commercial health insurance market. The MMA also expanded the role of private plans in Medicare, and increased price competition between those plans.
Also, Medicare is just now beginning to collect data on hospital quality. We expect this data will lead to future reimbursement policies that reward not just utilization, but good outcomes as well. In addition, the Administration is currently exploring ways to encourage the adoption of health care information technology, which shows the promise of reducing errors and waste
CONCLUSION
To conclude, let me say that I am encouraged that Social Security reform is finally being earnestly debated, and that all parties are motivated to make Social Security fair and permanently solvent. Today, my small contribution to this debate consists of four major points:
1. Social Security as currently designed cannot be sustained. We know with absolute certainty that Social Security will ultimately be reformed. The only question is when and how.
2. Social Security reform is urgent. The longer reform is delayed, the more unfair reform will be to future generations, and the more difficult it will be for individuals to plan their financial futures.
3. Social Security reform must make Social Security permanently solvent. Half measures ensure that further reforms will be necessary, and amount to a delay of reform that would be unfair to future generations.
4. Making Social Security permanently solvent requires that retirement incomes be pre-funded in PRAs rather than the Social Security Trust Fund. Any attempt to pre-fund retirement incomes in the Trust Fund would be undone by excessive government spending outside of Social Security.