The basic economic assumptions are embodied in three alternatives that are designed to provide a reasonable range of effects on Social Security’s financial status. The intermediate assumptions reflect the Trustees’ consensus expectation of an underlying general trend toward moderate economic growth throughout the projection period and the expected levels of various economic parameters. The low-cost assumptions represent a more optimistic outlook and assume relatively strong economic growth and relatively optimistic levels for other parameters. The high-cost assumptions represent a relatively pessimistic scenario, with weak economic growth in the short-range period and relatively pessimistic levels for other parameters. For this report, all three sets of assumptions include a gradual recovery from the recession that started in December 2007.
Actual economic data was available through the fourth quarter of 2009 at the time the assumptions for this report were set. The data indicated that economic activity peaked in December 2007
1 with the level of gross domestic product (GDP) above the long-term sustainable trend level. Economic growth subsequently weakened with the level of output reaching the sustainable trend level by the first quarter of 2008, and a bottom in the economic cycle for the second quarter of 2009. The actual growth rate in real GDP was positive for the third quarter of 2009 and strongly positive for the fourth quarter. For the intermediate and low-cost alternatives, the current
recession was projected to be followed by a recovery period with economic growth sufficient to return output to the sustainable trend level, but not beyond that level. For the high-cost alternative, the economy is assumed to experience a longer period of slow growth before returning to the sustainable level of output. Under all three sets of assumptions the economy is assumed to reach and maintain a sustainable, potential trend level of output by the end of 2019. Economic cycles are not included in the assumptions beyond the first 10 years of the projection period because complete cycles have little effect on the long-range estimates of financial status.
The remainder of this section discusses the key economic assumptions underlying the three sets of projections of the future financial status of the combined OASI and DI Trust Funds.
Total U.S. economy productivity is defined as the ratio of real GDP to hours worked by all workers.
2 The rate of change in total- economy productivity is a major determinant in the growth of average earnings. For the 40 years from 1968 to 2008, annual increases in total productivity averaged 1.7 percent, the result of average annual increases of 1.7, 1.3, 1.5, and 2.2 percent for the 10-year periods 1968-78, 1978-88, 1988-98, and 1998‑2008, respectively. For 2009, the estimated annual change in productivity is 2.5 percent.
It is most useful to consider historical average growth rates for complete economic cycles, because productivity growth can vary substantially within economic cycles. The annual increase in total productivity also averaged 1.7 percent over the last five complete economic cycles (measured from peak to peak), covering the 41-year period from 1966 to 2007. The annual increase in total productivity averaged 2.3, 1.2, 1.2, 1.8, and 2.1 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, and 2000-07, respectively.
The ultimate annual increases in total economy productivity are assumed to be 2.0, 1.7, and 1.4 percent for the low-cost, intermediate, and high-cost assumptions, respectively, and are consistent with ultimate annual increases in private non-farm business productivity of 2.4, 2.0, and 1.7 percent. The private non-farm business sector excludes the farm, government, non-profit institution, and private household sectors. These rates of increase are the same as those used in the 2009 report, and reflect the belief that recent strong growth in private non‑farm business productivity, after the relatively poor performance from 1973 to 1995, is consistent with future long-term growth that mirrors the long-term trends of the past.
For the intermediate assumptions, the annual change in productivity is assumed to be 3.7 percent for 2010 and 1.6 percent for 2011. Thereafter, the annual change is assumed to average 1.5 percent through 2019. The annual rate is assumed to reach its ultimate value of 1.7 percent in 2020 when the economy has fully recovered. For the low-cost assumptions, the annual change in productivity is assumed to be 4.2 percent for 2010 and 1.7 percent for 2011. The annual change is assumed to average 1.6 percent over the 2011 to 2019 period, and reach its ultimate value of 2.0 percent thereafter. For the high-cost assumptions, the annual change in productivity is assumed to be 3.3 percent for 2010 and 1.4 percent for 2011. The annual change is assumed to average 1.4 percent over the 2011 to 2019 period, and remain at that value thereafter.
Future changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI) will directly affect the OASDI program through the
automatic cost-of-living benefit increases. Future changes in the GDP price index (GDP deflator) affect the nominal levels of GDP, wages, self-employment income, average earnings, and
taxable payroll.
Historically, the CPI increased at an average annual rate of 4.6 percent for the 40 years from 1968 to 2008, the result of average annual increases of 6.5, 6.0, 3.2, and 2.8 percent for the 10-year periods 1968-78, 1978-88, 1988-98, and 1998-2008, respectively. The GDP deflator increased at an average annual rate of 4.1 percent from 1968 to 2008, the result of average annual increases of 6.3, 5.2, 2.5, and 2.4 percent for the same respective 10-year periods. For 2009, the annual change was ‑0.7 percent for the CPI and is estimated to be 1.2 percent for the GDP deflator.
The ultimate annual increases in the CPI are assumed to be 1.8, 2.8, and 3.8 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These rates of increase are the same as those used in the 2009 report, and reflect a belief that future inflationary shocks will likely be offset by succeeding periods of relatively slow inflation due to persistent international competition, and that future monetary policy will be similar to that of the last 20 years with its strong emphasis on holding the growth rate in prices to relatively low levels.
For the intermediate assumptions, the annual change in the CPI is assumed to be 2.0 percent for 2010. As the economy moves on a path toward full employment, the annual change is assumed to increase gradually from 1.7 percent in 2011 to the ultimate growth rate of 2.8 percent in 2014 and later. Because the actual level of the CPI in the third quarter of 2009 was below the level of the CPI in the third quarter of 2008, there was no automatic cost-of-living benefit increase for December 2009. Because the assumed level of the CPI in the third quarter of 2010 is still below the level of the CPI in the third quarter of 2008, no automatic cost-of-living benefit increase is projected for December 2010. Automatic cost-of-living benefit increases are projected to resume in December 2011 and occur in each subsequent year.
For the low-cost assumptions, the annual change in the CPI is assumed to average 1.5 percent for 2010 and 2011. The annual change in the CPI is assumed to increase from 1.6 percent for 2012 to its ultimate assumed annual change of 1.8 percent for 2013 and later. For the high-cost assumptions, the annual change in the CPI is assumed to average 2.3 percent for 2010 and 2011. The annual change in the CPI is assumed to increase from 4.3 percent for 2012 to 4.4 percent for 2013, then decrease to its ultimate assumed annual change of 3.8 percent for 2014 and later.
The ultimate annual increase in the GDP deflator is assumed to be equal to the annual increase in the CPI minus a price differential. The price differential is based primarily on methodological differences in the construction of the two indices. For the 2010 report, the ultimate annual increase in the GDP deflator is assumed to be equal to the annual increases in the CPI minus a 0.3, 0.4, and 0.5 percentage point price differential for the low-cost, intermediate, and high-cost alternatives, respectively. Varying the ultimate projected price differential across alternatives recognizes the historical variation in this concept. Accordingly, for the 2010 report, the ultimate annual increase in the GDP deflator is assumed to be 1.5 (1.8 less 0.3), 2.4 (2.8 less 0.4), and 3.3 (3.8 less 0.5) percent for the low-cost, intermediate, and high-cost alternatives, respectively. These are the same ultimate price differentials and GDP deflator growth rates assumed for the 2009 report.
The price differential is estimated to be ‑1.8 percentage points for 2009. Under the intermediate assumptions, the price differential is projected to be 0.7 percentage point for 2010. This swing in the price differential is due to the decline in oil prices for 2009 and the projected rise to a higher level for 2010. Changes in oil prices affect the CPI much more than the GDP deflator because oil represents a much larger share of U.S. consumption than of U.S. production. Oil prices are assumed to behave less cyclically after 2010 as the economy recovers. The price differential is assumed to be 0.3 percentage point in 2011 and 0.4 percentage point in 2012 and later.
The average level of nominal earnings in OASDI covered employment for each year has a direct effect on the size of the taxable payroll and on the future level of average benefits. In addition, under the automatic-adjustment provisions in the law, growth in the average wage in the U.S. economy directly affects certain parameters used in the OASDI benefit formulas and additional parameters used for the computation of the contribution and benefit base, the exempt amounts under the retirement
earnings test, the amount of earnings required for a quarter of coverage, and in certain circumstances, the automatic cost-of-living benefit increases.
Average U.S. earnings is defined as the ratio of the sum of total U.S. wage and salary disbursements and proprietor income to the sum of total U.S. military and civilian employment. The growth rate in average U.S. earnings for any period is equal to the combined growth rates for total U.S. economy productivity, average hours worked, the ratio of earnings to compensation (which includes fringe benefits), the ratio of compensation to GDP, and the GDP deflator. Assumed future growth rates in productivity and the GDP deflator are discussed in the previous two sections.
The average annual change in average hours worked was ‑0.3 percent over the last 40 years, and -0.7, -0.1, 0.3, and -0.6 percent for the 10-year periods 1968-78, 1978-88, 1988‑98, and 1998‑2008, respectively. The average annual change in average hours worked was -0.3 percent over the last five complete economic cycles covering the period from 1966 to 2007. The annual change in average hours worked averaged -0.7, -0.7, 0.0, 0.1, and ‑0.6 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, and 2000‑07, respectively.
For the 2010 report, the ultimate annual rates of change for average hours worked are assumed to be 0.1, 0.0, and -0.1 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These ultimate annual rates of change for average hours worked are the same as those assumed for the 2009 report.
The average annual change in the ratio of earnings to compensation was ‑0.2 percent from 1968 to 2008. Most of this decrease has been due to the relative increase in employer-sponsored group health insurance for wage workers. Assuming that the level of total employee compensation is not affected by the amount of employer-sponsored group health insurance, any increase or decrease in employer-sponsored group health insurance leads to a commensurate decrease or increase in other components of compensation, including wages.
For the 2009 report, the assumed ultimate annual rates of change in the ratio of wages to employee compensation were -0.1, -0.2, and -0.3 percent for the low-cost, intermediate, and high-cost assumptions, respectively. For each alternative, a constant ultimate annual rate of change in the ratio of wages to employee compensation was assumed. For this year’s report, this assumption was changed in two steps: first, the projected growth rates of various components of compensation were refined so that they are allowed to change over time, rather than being held constant at a summarized average rate; second, these projected “baseline” growth rates were updated to reflect the estimated effects of legislation since last year’s report.
In the first step, specific annual baseline assumptions were made for the growth in the pension and health insurance components of compensation. The share of employee compensation used for pension costs that are exempt from the payroll tax is assumed to increase as life expectancy and potential time in retirement increase. The share of employee compensation used to pay for the cost of employer-sponsored group health insurance, which is exempt from the payroll tax, is now assumed to vary annually, consistent with trends assumed for components of health care cost in the national economy. Together, these changes result in somewhat slower growth in non-taxable components of compensation early and late in the 75-year projection period, and faster growth in the middle of the period, than assumed for last year’s report. However, the average annual decrease in the ratio of wages to compensation over the 75-year period is unchanged at 0.2 percent for the intermediate assumptions.
In the second step, the annual baseline rates of change in the ratio of wages to employee compensation were adjusted to reflect new legislation. In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act became law. This new legislation is not assumed to affect future growth in total economic output or total compensation. However, this legislation is assumed to affect the components of compensation and, in particular, the annual growth rates in employer-sponsored group health insurance. Compared to the baseline, the projected average annual growth rate for the total cost of employer-sponsored group health insurance is lower, and the average annual rate of decline in the ratio of wages to compensation is correspondingly lower by about 0.1 percent. Most of this change is due to the assumption that an excise tax on employer-sponsored group health insurance, effective beginning in 2018, will lead to slower growth in the total cost of employer-sponsored group health insurance. Such effect of the excise tax on employer-sponsored group health insurance is expected to increase over time because the threshold premium levels above which the tax applies are indexed by all-items CPI, which is assumed to grow slower than the cost of providing health insurance. These projections for annual percent changes in employer-sponsored group health insurance cost on a year-by-year basis are consistent with national health estimates from the Office of the Actuary at the Centers for Medicare and Medicaid Services.
For the 2010 report, the assumed annual rates of change in the ratio of wages to employee compensation average 0.0, ‑0.1, and ‑0.2 percent for the low-cost, intermediate, and high-cost assumptions, respectively. Under the intermediate assumptions, the ratio of wages to employee compensation is projected to decline from 0.810 for 2009 to 0.742 for 2084. The ratio of compensation to GDP is assumed to be stable at 0.648 after 2019.
The projected average annual growth rate in average U.S. earnings from 2019 to 2084 is about 4.0 percent for the intermediate assumptions. This growth rate reflects the average annual growth rate of approximately ‑0.1 percent for the ratio of earnings to compensation, and the assumed ultimate annual growth rates of 1.7, 0.0, and 2.4 percent for productivity, average hours worked, and the GDP deflator, respectively. Similarly, the projected average annual growth rate in average nominal U.S. earnings is 3.6 percent for the low-cost assumptions and 4.4 percent for the high-cost assumptions.
Over long periods, the average annual growth rate in the average wage in OASDI covered employment (henceforth the “average covered wage”) is expected to be very close to the average annual growth rate in average U.S. earnings. Thus, the assumed average annual growth rates in the average covered wage from 2019 to 2084 are 3.6, 4.0, and 4.4 percent for the low-cost, intermediate, and high-cost assumptions, respectively. For the intermediate assumptions, the annual rate of change in the average covered wage is assumed to be ‑0.6 percent for 2009, which reflects the recession low point. As the economy recovers, the annual rate of change in the average covered wage is assumed to average 4.5 percent from 2010 to 2012 and 4.4 percent from 2013 to 2019. Thereafter, the assumed average annual rate of change in the average covered wage is 4.0 percent.
For simplicity, real increases in the average OASDI covered wage have traditionally been expressed in the form of real-wage differentials — i.e., the percentage change in the average covered wage minus the percentage change in the CPI. This differential is closely related to assumed growth rates in average earnings and productivity, which are discussed in the previous sections. For the 40-year period including 1969 through 2008, the real-wage differential averaged 0.8 percentage point, the result of averages of 0.8, 0.3, 1.1, and 0.8 percentage points for the 10-year periods 1969-78, 1979-88, 1989-98, and 1999‑2008, respectively.
For the years 2020‑84, the annual real-wage differentials for OASDI covered employment average 1.8, 1.2, and 0.6 percentage points for the low-cost, intermediate, and high-cost assumptions, respectively.
Based on preliminary data, the real-wage differential is estimated to be 0.0 percentage point for 2009. For the intermediate assumptions, the real-wage differential is projected to be 3.1 percentage points for 2010 and to average 2.3 percentage points from 2011 to 2013, reflecting the economic recovery. Thereafter, the real-wage differential is assumed to gradually decline to 1.3 percentage points in 2019 and to average 1.2 percentage points from 2019 to 2084. For the low-cost assumptions, the real-wage differential is projected to be 3.6 percentage points for 2010 and to average 2.2 percentage points from 2010 to 2019 and 1.8 percentage points from 2019 to 2084. For the high-cost assumptions, the real-wage differential is projected to be 2.4 percentage points for 2010, to vary between 1.4 and 1.8 percentage points between 2011 and 2016, and then to decline to 0.8 percentage point by 2019 and to average 0.6 percentage point from 2019 to 2084.
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The civilian labor force is projected by age, sex, marital status, and presence of children. Projections of the labor force participation rates for each subgroup take into account disability prevalence, educational attainment, the average level of Social Security retirement benefits, the state of the economy, and the change in life expectancy. The projections also include a “cohort effect” that applies differences in participation rates for a cohort at a specific age, relative to earlier cohorts at the same age, to participation rates for that cohort at older ages.
The annual rate of growth in the size of the labor force decreased from an average of about 2.1 percent during the 1970s and 1980s to about 1.1 percent from 1990 to 2009. Further slowing of labor force growth is projected due to a substantial slowing of growth in the working age population in the future — a natural consequence of the
baby-boom generation approaching retirement and succeeding lower-birth-rate cohorts reaching working age. Under the intermediate assumptions, the labor force is projected to increase by about 0.7 percent per year, on average, through 2019. Thereafter, the labor force is projected to increase by 0.5 percent per year between 2019 and 2050, and by 0.4 percent over the remainder of the 75‑year projection period.
The projected labor force participation rates are not basic assumptions. They are derived from a historically-based structural relationship using demographic and economic assumptions specific to each alternative. However, the participation rates are not highly sensitive to most of the demographic and economic assumptions. Accordingly, the projected labor force participation rates do not vary substantially into the future and across alternatives.
Historically, labor force participation rates have been influenced substantially by trends in demographics and pensions. Between the mid‑1960s and the mid‑1980s, labor force participation rates at ages 50 and over declined for males and were fairly stable for females. The overall decline was facilitated by the large numbers of workers entering the labor force from the baby-boom generation, and from the female population in general, during this period. This increasing supply of labor allowed employers to offer early-retirement options that were attractive. Between the mid‑1980s and about 1995, participation rates roughly stabilized for males and increased for females. Since 1995, however, participation rates for both sexes at ages 50 and over have generally risen significantly. This rise reflects a decrease in early-out options and relatively strong economic growth.
For the future, changes in available benefit levels from Social Security and increases in the normal retirement age are expected to encourage work at older ages. Some of these factors are modeled directly. However, other factors, such as the trend away from private defined-benefit pension plans (that often provide incentives to retire) toward defined-contribution plans, are expected to provide additional upward pressure on labor force participation rates. In addition to this shift in private pensions, the aging of the population is expected to both increase the demand for workers and, through improved health associated with greater life expectancy, improve the ability of the older population to work. Longer life expectancy will also increase the assets needed to live comfortably through retirement years, thus encouraging workers to stay employed longer. In order to account for these effects, which are directly or indirectly related to increases in life expectancy, projected participation rates for prime age and older males and females are adjusted upward in relation to assumed increases in life expectancy. For the intermediate projections, this adjustment for changes related to life expectancy adds about 1.6 percent to the total labor force by 2084.
For men age 16 and over, the projected age-adjusted labor force participation rates for 2084 are 73.0, 72.1, and 71.2 percent for the low-cost, intermediate, and high-cost assumptions, respectively, compared to the 2008 level of 73.0 percent. (Age-adjusted labor force participation rates are adjusted to the 2008 age distribution of the civilian noninstitutional U.S. population.) These rates reflect the net effect of increases due to assumed improvements in life expectancy and decreases due to higher assumed disability prevalence rates and an increasing proportion of males who never marry. For women age 16 and over, the projected age-adjusted labor force participation rates for 2084 are 61.0, 60.4, and 59.6 percent, for the low-cost, intermediate, and high-cost assumptions, respectively, compared to the 2008 level of 59.5 percent. These projections reflect the combination of decreases due to higher assumed disability prevalence rates, increases due to assumed improvements in life expectancy, and increases due to assumed changes in the proportion of females who are separated, widowed, divorced, or never married.
The unemployment rates presented in table V.B2 are in the most commonly cited form, the civilian rate. For years through 2019, total civilian rates are presented without adjustment for the changing age-sex distribution of the population. For years after 2019, unemployment rates are presented as age-sex-adjusted rates (using the age-sex distribution of the 2008 civilian labor force). Age-sex-adjusted rates allow for more meaningful comparisons across longer time periods. The effect of this adjustment through 2019 is small.
The total civilian unemployment rate reflects the projected levels of unemployment for various age-sex subgroups of the population. The unemployment rate for each subgroup is projected based on a specification (consistent with Okun’s Law
3) relating changes in the unemployment rate to the changes in the economic cycle, as measured by the ratio of actual to potential GDP. For each alternative, the total civilian unemployment rate is projected to move toward the ultimate assumed rate as the economy moves toward the long-range sustainable growth path.
The ultimate age-sex-adjusted unemployment rate for each alternative is assumed to be reached by 2019. The ultimate assumed unemployment rates are 4.5, 5.5, and 6.5 percent for the low-cost, intermediate, and high-cost assumptions, respectively. These values are the same as those assumed for the 2009 report.
The real growth rate in GDP equals the combined growth rates for total employment, productivity, and average hours worked. Total employment is the sum of the U.S. Armed Forces and total civilian employment, which is based on the projected total civilian labor force and unemployment rates. For the 40-year period from 1968 to 2008, the average growth rate in real GDP was 3.0 percent, combining the approximate growth rates of 1.5, 1.7, and ‑0.3 percent for its components — total employment, productivity, and average hours worked, respectively.
For the intermediate assumptions, the average annual growth in real GDP is projected to be 3.0 percent from 2009 to 2019, the approximate sum of component growth rates of 1.1 percent for total employment, 1.7 percent for productivity, and 0.1 percent for average hours worked. This projected average annual growth in real GDP of 3.0 percent can also be separated into an underlying sustainable trend rate of change of 2.3 percent for this period, plus an above-trend growth rate of 0.7 percent that is mostly associated with a relatively rapid increase in employment as the economy recovers and the unemployment rate falls from near 10.0 percent in 2009 to its assumed ultimate level of 5.5 percent in 2018. After 2019, no economic cycles are projected. Accordingly, the projected annual growth rate in real GDP is determined by the projected full-employment growth rate for total employment and the assumed full-employment growth rates for total U.S. economy productivity and average hours worked. After 2050, the annual growth in real GDP is 2.1 percent due to the assumed ultimate growth rates of 0.4 percent for total employment, 1.7 percent for productivity, and 0.0 percent for average hours worked.
For the low-cost assumptions, annual growth in real GDP is projected to average 3.5 percent over the decade ending in 2019. The relatively faster growth is due mostly to higher assumed rates of growth for employment and worker productivity. For the high-cost assumptions, annual growth in real GDP is projected to average 2.4 percent for the decade ending in 2019.
The average annual nominal and real interest rates for new trust fund assets are presented in table
V.B2. The nominal rate is the average of the nominal interest rates for special U.S. Government obligations issuable to the trust funds in each of the 12 months of the year. Interest for these securities is generally compounded semiannually. The real interest rate (ex post) is defined to be the annual compound yield rate for investments in these securities divided by the annual rate of growth in the CPI for the first year after issuance. The real rate shown for each year reflects the actual realized (historical) or expected (future) annual real yield on securities issuable in the prior year.
In developing a reasonable range of assumed ultimate future real interest rates for the three alternatives, historical experience was examined for the 40 years, 1969-2008, and for each of the 10-year subperiods, 1969-78, 1979-88, 1989-98, and 1999-2008. For the 40-year period, the real interest rate averaged 2.8 percent per year. For the four 10-year subperiods, the real interest rates averaged 0.3, 4.5, 4.3, and 2.2 percent, respectively. The assumed ultimate real interest rates are 3.6 percent, 2.9 percent, and 2.1 percent for the low-cost, intermediate, and high-cost assumptions, respectively, and are unchanged from the 2009 report. These ultimate real interest rates, when combined with the ultimate CPI assumptions of 1.8, 2.8, and 3.8 percent, yield ultimate nominal interest rates of about 5.4 percent for the low-cost assumptions, about 5.7 percent for the intermediate assumptions, and about 5.9 percent for the high-cost assumptions. These ultimate nominal rates are assumed to be reached by the end of the short-range period.
The actual average annual nominal interest rate was 3.6 percent for 2008, which means that assets newly invested in 2008 would increase by 3.6 percent a year later, with interest. Because average prices actually declined from 2008 to 2009 by 0.7 percent, the purchasing power of assets invested in 2008 actually increased by about 4.4 percent a year later. Therefore, the annual real interest rate for 2009 is 4.4 percent. For the next 10-year short-range projection period, nominal interest rates are projected based on changes in the business cycle and in the CPI. Under the intermediate assumptions, the nominal interest rate is projected to rise to 6.1 percent in 2014 before declining to the ultimate assumed level of 5.7 percent for 2019. For the low-cost assumptions, the average annual nominal interest rate is assumed to reach an ultimate level of about 5.4 percent for 2018. For the high-cost assumptions, it is assumed to peak at 7.0 percent for 2013, and then decline to an ultimate rate of about 5.9 percent by 2018.
