2002 OASDI Trustees Report

B. LONG-RANGE ESTIMATES

Three financial measures are useful in assessing the actuarial status of the Social Security trust funds under the financing approach specified in current law: (1) annual income and cost rates, and balances, (2) trust fund ratios, and (3) actuarial balance. The first long-range estimates presented are the series of projected annual balances, which are the differences between the projected annual income rates and annual cost rates. In assessing the financial condition of the program, particular attention should be paid to the level of the annual balances at the end of the long-range period and the time at which the annual balances may change from positive to negative values. The next measure to be discussed is the pattern of projected trust fund ratios. The trust fund ratio represents the proportion of a year's projected outgo that can be paid with the funds available at the beginning of the year. Particular attention should be paid to the amount and year of maximum trust fund ratio, to the year of exhaustion of the funds, and to stability of the trust fund ratio in cases where the ratio remains positive at the end of the long-range period. The final measure discussed in this section is the actuarial balance, which summarizes the total income and expenditures over the valuation period and indicates whether projected income will be adequate. This section also includes a comparison of workers to beneficiaries, the long-range test of close actuarial balance, and the reasons for change in the actuarial balance from the last report.

If the 75-year actuarial balance is zero (or positive) then the trust fund ratio at the end of the period, by definition, will be at 100 percent (or greater) and financing for the program is considered to be adequate for the 75-year period. Whether or not financial adequacy is stable in the sense that it is likely to continue for subsequent 75-year periods in succeeding reports is also important when considering the actuarial status of the program. One indication of this stability is the behavior of the trust fund ratio at the end of the projection period. If projected trust fund ratios for the last several years of the long-range period are constant or rising, then it is likely that subsequent Trustees' Reports will also show projections of financial adequacy (assuming no changes in demographic and economic assumptions).

1. Annual Income Rates, Cost Rates, and Balances

Basic to the consideration of the long-range actuarial status of the trust funds are the concepts of income rate and cost rate, each of which is expressed as a percentage of taxable payroll. The annual income rate is the ratio of income from revenues (payroll tax contributions and income from the taxation of benefits) to the OASDI taxable payroll for the year. The OASDI taxable payroll consists of the total earnings which are subject to OASDI taxes, with some relatively small adjustments.¹ Because the taxable payroll reflects these adjustments, the annual income rate can be defined to be the sum of the OASDI combined employee-employer contribution rate (or the payroll-tax rate) scheduled in the law and the rate of income from taxation of benefits (which is, in turn, expressed as a percentage of taxable payroll). As such, it excludes reimbursements from the General Fund of the Treasury for the costs associated with special monthly payments to certain uninsured persons who attained age 72 before 1968 and who have fewer than 3 quarters of coverage, and net investment income.

The annual cost rate is the ratio of the cost (or outgo, expenditures, or disbursements) of the program to the taxable payroll for the year. In this context, the outgo is defined to include benefit payments, special monthly payments to certain uninsured persons who have 3 or more quarters of coverage (and whose payments are therefore not reimbursable from the General Fund of the Treasury), administrative expenses, net transfers from the trust funds to the Railroad Retirement program under the financial-interchange provisions, and payments for vocational rehabilitation services for disabled beneficiaries. For any year, the income rate minus the cost rate is referred to as the balance for the year. (In this context, the term balance does not represent the assets of the trust funds, which are sometimes referred to as the balance in the trust funds.)

Table IV.B1 presents a comparison of the estimated annual income rates and cost rates by trust fund and alternative. Detailed long-range projections of trust fund operations, in nominal dollar amounts, are shown in table VI.E9.

The projections for OASI under the intermediate assumptions show the income rate increasing slowly and steadily due to the combination of the flat payroll tax rate and the gradually increasing effect of the taxation of benefits. The pattern of the cost rate is much different. It is projected to remain fairly stable for the next several years. However, from about 2010 to 2030 the cost rate increases rapidly as the baby-boom generation reaches retirement age. After 2030 the cost rate rises less rapidly through 2037 and then declines slightly for the next 9 years as the baby-boom generation ages and begins to diminish and the relatively small birth cohorts of the late 1970s reach retirement age. Thereafter, the cost rate rises steadily, but slowly, reflecting projected reductions in death rates and continued relatively low birth rates, reaching 17.18 percent of taxable payroll for 2076. The income rate under the intermediate assumptions also rises, reaching 11.54 percent of taxable payroll for 2076.

Projected income rates under the low cost and high cost sets of assumptions are very similar to those projected for the intermediate assumptions as they are largely a reflection of the tax rates specified in the law. OASI cost rates for the low cost and high cost assumptions differ significantly from those projected for the intermediate assumptions, but follow generally similar patterns. For the low cost assumptions, the cost rate declines somewhat for the first 5 years, and then rises, reaching the current level around 2013 and a peak of 13.35 percent of payroll for 2034. The cost rate then declines gradually, reaching a level of 12.42 percent of payroll for 2076. For the high cost assumptions, the cost rate rises generally throughout the 75-year period. It rises at a relatively fast pace between 2010 and 2030 because of the aging of the baby-boom generation. During the third 25-year subperiod, the projected cost rate continues rising and reaches 24.76 percent of payroll for 2076.

The projected pattern of the OASI annual balance is important in the analysis of the financial condition of the program. Under the intermediate assumptions the annual balance is positive for 16 years (through 2017) and is negative thereafter. This annual deficit rises rapidly, reaching over 2 percent of taxable payroll by 2024, and continues rising thereafter, to a level of 5.64 percent of taxable payroll for 2076.

Under the low cost assumptions the projected OASI annual balance is positive for 19 years (through 2020) and thereafter is negative. The deficit under the low cost assumptions rises to a peak of 2.08 percent of taxable payroll for 2034, but declines over the next 15 to 20 years, as the effect of the baby-boom generation diminishes and the assumed higher fertility rates increase the size of the work force. The deficit under the low cost assumptions remains fairly stable over the period 2051 through 2076. Under the high cost assumptions, however, the OASI balance is projected to be positive for only 13 years (through 2014) and to be negative thereafter, with a deficit of 2.12 percent for 2020, 7.78 percent for 2050, and 12.81 percent of payroll for 2076.

Notes:
1. The income rate excludes interest income and certain transfers from the General Fund of the Treasury.

2. Totals do not necessarily equal the sums of rounded components.

Under the intermediate assumptions, the cost rate for DI generally increases over the long-range period from 1.67 percent of taxable payroll for 2002, reaching 2.65 for 2076. The income rate increases only very slightly from 1.82 percent of taxable payroll for 2002 to 1.87 percent for 2076. The annual balance turns negative in 2009, and the annual deficit reaches 0.78 percent for 2076.

Under the low cost assumptions, the DI cost rate increases much less, reaching 1.82 percent for 2076, with a positive annual balance throughout the period. For the high cost assumptions, DI cost rises much more, reaching 3.75 percent for 2076, with an annual deficit beginning in 2005 and reaching 1.85 percent for 2076.

Also of interest are the annual income rate, cost rate, and balance for the OASDI program. These rates are shown in table IV.B1 and are discussed in section II.D.

Figure IV.B1 shows in graphical form the patterns of the OASI and DI annual income rates and cost rates. (The combined OASI and DI rates are shown in figure II.D2 on page 13.) The income rates shown here are only for alternative II in order to simplify the graphical presentation and because, as shown in table IV.B1, the variation in the income rates by alternative is very small. Income rates increase generally, but at a slow rate for each of the alternatives over the long-range period. Both increases in the income rate and variation among the alternatives result from the relatively small component of income from taxation of benefits. Increases in income from taxation of benefits reflect increases in the total amount of benefits paid and the fact that an increasing share of individual benefits will be subject to taxation, because benefit taxation threshold amounts are not indexed.

The patterns of the annual balances for OASI and DI are indicated in figure IV.B1. For each alternative, the magnitude of each of the positive balances in the early years, as a percent of taxable payroll, is represented by the distance between the appropriate cost-rate curve and the income-rate curve above it. The magnitude of each of the deficits in subsequent years is represented by the distance between the appropriate cost-rate curve and the income-rate curve below it.

In the future, the cost of OASI, DI and the combined OASDI program as a percent of taxable payroll will not necessarily be within the range encompassed by alternatives I and III. Nonetheless, because alternatives I and III define a reasonably wide range of demographic and economic conditions, the resulting estimates delineate a reasonable range for consideration of potential future program costs.

Figure IV.B1.—Long-Range OASI and DI Annual Income Rates and Cost Rates

[As a percentage of taxable payroll]

The cost of the OASDI program has been discussed in this section in relation to taxable payroll, which is a program-related concept that is very useful in analyzing the financial status of the OASDI program. The cost can also be discussed in relation to broader economic concepts, such as the gross domestic product (GDP). OASDI outlays generally rise from about 4.5 percent of GDP currently to about 7.0 percent of GDP by the end of the 75-year projection period under alternative II. Discussion of both the cost and the taxable payroll of the OASDI program in relation to GDP is presented in appendix VI.E.2 beginning on page 162.

2. Comparison of Workers to Beneficiaries

The primary reason that the estimated OASDI cost rate increases rapidly after 2010 is that the number of beneficiaries is projected to increase more rapidly than the number of covered workers. This occurs because the relatively large number of persons born during the baby-boom generation will reach retirement age, and begin to receive benefits, while the relatively small number of persons born during the subsequent period of low fertility rates will comprise the labor force. A comparison of the numbers of covered workers and beneficiaries is shown in table IV.B2.

Notes:
1. The number of beneficiaries does not include certain uninsured persons, most of whom both attained age 72 before 1968 and have fewer than 3 quarters of coverage, in which cases the costs are reimbursed by the General Fund of the Treasury. Totals do not necessarily equal the sums of rounded components.

2. Historical covered worker data are subject to revision.

Table IV.B2 shows that the number of covered workers per beneficiary, which was about 3.4 in 2001, is estimated to decline in the future. Based on the low cost assumptions, for which high fertility rates and small reductions in death rates are assumed, the ratio declines to 2.3 by 2030, and then rises back to a level of 2.4 by 2040. Based on the high cost assumptions, for which low fertility rates and large reductions in death rates are assumed, the decline is much greater, reaching 1.8 by 2034, and 1.4 workers per beneficiary by 2068. Based on the intermediate assumptions, the ratio declines to 2.1 by 2029, and 1.9 workers per beneficiary by 2059.

The impact of the demographic shifts under the three alternatives on the OASDI cost rates is better understood by considering the projected number of beneficiaries per 100 workers. As compared to the 2001 level of 30 beneficiaries per 100 covered workers, this ratio is estimated to rise significantly by 2080 to 42 under the low cost assumptions, 56 under the intermediate assumptions, and 76 under the high cost assumptions. The significance of these numbers can be seen by comparing figure IV.B1 to figure IV.B2.

Figure IV.B2.—Number of OASDI Beneficiaries Per 100 Covered Workers

For each alternative, the shape of the curve in figure IV.B2, which shows beneficiaries per 100 covered workers, is strikingly similar to that of the corresponding cost-rate curve in figure IV.B1, thereby emphasizing the extent to which the cost of the OASDI program as a percentage of taxable payroll is determined by the age distribution of the population. Because the cost rate is basically the product of the number of beneficiaries and their average benefit, divided by the product of the number of covered workers and their average taxable earnings (and because average benefits rise at about the same rate as average earnings), it is to be expected that the pattern of the annual cost rates is similar to that of the annual ratios of beneficiaries to workers. A graphical presentation of covered workers per beneficiary is shown in figure II.D3 on page 14 of the Overview.

3. Trust Fund Ratios

Trust fund ratios are useful indicators of the adequacy of the financial resources of the Social Security program at any point in time. For any year in which the projected trust fund ratio is positive (i.e., the trust fund holds assets at the beginning of the year), but is not positive for the following year, the trust fund is projected to become exhausted during the year. Under present law, the OASI and DI Trust Funds do not currently have the authority to borrow. Therefore, exhaustion of the assets in either fund during a year, would mean there are no longer sufficient funds to cover the full amount of benefits payable under present law.

The trust fund ratio also serves an additional important purpose in assessing the actuarial status of the program. When the financing is adequate for the timely payment of full benefits throughout the long-range period, the stability of the trust fund ratio toward the end of the period indicates the likelihood that this projected adequacy will continue for subsequent Trustees' Reports. If the trust fund ratio toward the end of the period is level (or increasing) then projected adequacy for the long-range period is likely to continue for subsequent reports.

Table IV.B3 shows, by alternative, the estimated trust fund ratios (without regard to advance tax transfers that would be effected after the end of the 10-year, short-range period) for the separate and combined OASI and DI Trust Funds. Also shown in this table is the first year in which a fund is estimated to be exhausted, reflecting the effect of the provision for advance tax transfers. The patterns of the OASI and DI trust fund ratios, over the 75-year period, are shown graphically in figure IV.B3 for all three sets of assumptions. A graphical presentation of the combined OASDI ratios is shown in figure II.D4 on page 15.

Based on the intermediate assumptions, the OASI trust fund ratio rises steadily from 272 percent at the beginning of 2002, reaching a peak of 522 percent at the beginning of 2015. This increase in the OASI trust fund ratio results from the fact that the annual income rate (which excludes interest) exceeds annual outgo for several years (see table IV.B1). Thereafter, the OASI trust fund ratio declines steadily, with the OASI Trust Fund becoming exhausted in 2043. The DI trust fund ratio follows a pattern that is similar but unfolds more rapidly. The DI trust fund ratio is estimated to rise from 197 percent at the beginning of 2002 to a peak of 246 percent for 2007, and to decline thereafter until becoming exhausted in 2028.

The trust fund ratio for the combined OASI and DI Trust Funds rises from 261 percent for 2002 to a peak of 471 percent at the beginning of 2015. Thereafter, the ratio declines, with the combined funds becoming exhausted in 2041. Based on the intermediate estimates in last year's report, the peak fund ratio for the combined funds was estimated to be 436 percent for 2014 and the year of exhaustion was estimated to be 2038.

The trust fund ratio for the OASDI program first declines in 2016, about 1 year before annual expenditures begin to exceed noninterest income. This occurs because the increase in trust fund assets during 2015, which reflects interest income and a small excess of noninterest income over cost, occurs at a slower rate than does the increase in the annual cost of the program between 2015 and 2016.

After 2015 the dollar amount of assets is projected to continue to rise through the beginning of 2027 because interest income more than offsets the shortfall in noninterest income. Beginning in 2017, the OASDI program is projected to experience increasingly large cash-flow shortfalls that will require the trust funds to redeem special public-debt obligations of the General Fund of the Treasury. This will differ from the experience of recent years when the trust funds have been net lenders to the General Fund of the Treasury. The change in the cash flow between the trust funds and the general fund is expected to have important public policy and economic implications that go well beyond the operation of the OASDI program itself. Discussion of these issues is outside the scope of this report.

Based on the low cost assumptions, the trust fund ratio for the DI program increases throughout the long-range projection period, reaching the extremely high level of 1,459 percent for 2077. At the end of the long-range period, the DI trust fund ratio is rising by 20 percentage points per year. Thus, subsequent reports are likely to contain projections of adequate long-range financing of the DI program under a similar optimistic set of assumptions. For the OASI program, the trust fund ratio rises to a peak of 633 percent for 2018, dropping thereafter to a level of 377 percent by 2077. At the end of the period the OASI trust fund ratio is declining by 4 percentage points per year. The long term outlook for the DI program is improved more than for the OASI program largely because lower assumed disability incidence rates have a substantial effect on the DI program but little net effect on the OASI program. For the OASDI program, the trust fund ratio follows a pattern similar to that for OASI, peaking at 614 percent for 2019, and then falling to 515 percent for 2043. However, after 2043 the combined OASI and DI trust fund ratio stays about level, with a value of 515 percent for 2077, with an annual decline at a rate of 1 percentage point. Thus, due to the size of the trust fund ratios and their near stability, subsequent Trustees' Reports are likely to contain projections of adequate long-range financing of the OASI and combined OASI and DI program under the low cost assumptions. A stable trust fund ratio at the end of the valuation period indicates that the actuarial balance for Trustees' Reports in subsequent years can be expected to remain about the same as long as assumptions are realized.

In contrast, under the high cost assumptions, the OASI trust fund ratio is estimated to peak at 425 percent for 2013, thereafter declining to fund exhaustion by the end of 2032. The DI trust fund ratio is estimated to peak at 205 percent for 2004, thereafter declining to fund exhaustion by the end of 2015. The combined OASDI trust fund ratio is estimated to rise to a peak of 359 percent for 2012, declining thereafter to fund exhaustion by the end of 2029.

Thus, because the high ultimate cost rates are projected under all but the low cost assumptions, it is likely that income will eventually need to be increased and/or program costs will need to be reduced in order to prevent the trust funds from becoming exhausted.

Even under the high cost assumptions, however, the combined OASI and DI funds on hand plus their estimated future income would be able to cover their combined expenditures for 27 years into the future (until 2029). Under the intermediate assumptions the combined starting funds plus estimated future income would be able to cover expenditures for about 39 years into the future (until 2041). The program would be able to cover expenditures for the indefinite future under the more optimistic low cost assumptions. In the 2001 report, the combined trust funds were projected to be exhausted in 2027 under the high cost assumptions and in 2038 under the intermediate assumptions.

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Note: See definition of trust fund ratio on page 197. The combined ratios shown for years after the DI fund is estimated to be exhausted are theoretical and are shown for informational purposes only.

A graphic illustration of the trust fund ratios for the separate OASI and DI Trust Funds is shown in figure IV.B3 for each of the alternative sets of assumptions. A graphic illustration of the trust fund ratios for the combined trust funds is shown in figure II.D4.

Figure IV.B3.—Long-Range OASI and DI Trust Fund Ratios

[Assets as a percentage of annual expenditures]

4. Summarized Income Rates, Cost Rates, and Balances

Summarized values for the full 75-year period are useful in analyzing the long-range adequacy of financing for the program over the period as a whole under present law and under proposed modifications to the law. In order to focus on the full 75-year period as well as on broad patterns through the period, tables IV.B4 and IV.B5 summarize, on a present-value basis, the projected annual figures shown in table IV.B1 for various periods within the overall 75-year projection period.

Table IV.B4 shows rates on a present-value basis summarized for each of the 25-year subperiods, excluding both the assets of the trust funds on hand at the beginning of the period and the cost of accumulating a target trust fund balance by the end of the period. These rates are useful for comparing the total cash flows of tax income and expenditures, as an indicator of the degree to which tax income during the period is sufficient to meet the outgo estimated for the period.

For the OASDI program, a positive balance is projected for the first 25-year subperiod under both the low cost and intermediate assumptions. A deficit is projected for the first 25-year subperiod under the high cost assumptions. Deficits are projected for the second and third subperiods under all three alternatives.

Note: Totals do not necessarily equal the sums of rounded components.

Table IV.B5 shows summarized rates for valuation periods of the first 25, the first 50, and the entire 75 years of the long-range projection period, including the funds on hand at the start of the period and the cost of accumulating a target trust fund balance equal to 100 percent of annual expenditures by the end of the period. The actuarial balance for each of these three valuation periods is equal to the difference between the summarized income rate and the summarized cost rate for the corresponding period. An actuarial balance of zero for any period would indicate that estimated outgo for the period could be met, on average, with a remaining trust fund balance at the end of the period equal to 100 percent of the following year's outgo. A negative actuarial balance indicates that, over the next 75 years, the present value of income to the program plus the existing trust fund falls short of the present value of expenditures by the program plus the cost of reaching a target trust fund balance of 1 year's expenditures by the end of the period—deficits for some years within the period are not fully offset by surpluses in other years. Combined with a falling trust fund ratio, this signals the possibility of continuing cash-flow deficits, implying that the current-law level of financing is not sustainable.