I. OVERVIEW

A. INTRODUCTION

The Old-Age, Survivors, and Disability Insurance (OASDI) program in the United States provides protection against the loss of earnings due to retirement, death, or disability. The OASDI program consists of two separate parts which pay monthly benefits to workers and their families--Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI). Under OASI monthly benefits are paid to retired workers and their families and to survivors of deceased workers. Under DI monthly benefits are paid to disabled workers and their families.

The Board of Trustees is established under the Social Security Act to oversee the financial operations of the Federal Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust Fund. The Board is composed of six members, four of whom serve automatically by virtue of their positions in the Federal Government: the Secretary of the Treasury, who is the Managing Trustee, the Secretary of Labor, the Secretary of Health and Human Services, and the Commissioner of Social Security. The other two members are appointed by the President and confirmed by the Senate to serve as public representatives. Stanford G. Ross and David M. Walker began serving 4-year terms on October 2, 1990. They have continued serving through the issuance of this report under the provision of the Social Security Act that allows a public representative whose term has expired to continue in the position until the earlier of the time at which a successor takes office or the Board's next annual report is issued. The Commissioner of Social Security became a member of the Board effective March 31, 1995, under the Social Security Independence and Program Improvements Act of 1994 (Public Law 103-296, signed August 15, 1994).

The Social Security Act requires that the Board, among other duties, report annually to the Congress on the financial and actuarial status of the OASI and DI Trust Funds. This annual report, for 1995, is the 55th such report.

B. ADVISORY COUNCIL

The Secretary of Health and Human Services on June 9, 1994, announced the appointment of an Advisory Council on Social Security under the provisions of section 706 of the Social Security Act which were in effect prior to the enactment of the Social Security Independence and Program Improvements Act of 1994 (Public Law 103-296) on August 15, 1994. The provisions of the Social Security Act prior to enactment of Public Law 103-296 provided for the appointment of an Advisory Council every 4 years to examine issues affecting the OASDI program as well as the Medicare program. Under the provisions of Public Law 103-296, this is the last Advisory Council to be appointed.

The Council is composed of a Chair and 12 members representing employers and employees, self-employed persons, and the public. The Council is focusing on the OASDI program. Among the areas the Secretary has specifically asked the Council to examine is Social Security financing. The Council has been charged with developing recommendations for improving the long-range financial status of the OASDI program.

The Council convened a Technical Panel on Assumptions and Methods to review the assumptions and methodology used to project the future financial status of the OASDI program, including, if necessary, measures of the financial soundness of the program. (A Technical Panel on Trends and Issues in Retirement Saving was also convened.)

The Council is expected to provide a report to the Secretary in 1995. The Council's final report will then be transmitted by the Secretary to the Congress and to the Board of Trustees. Recommendations of the Council will be included in a later annual report of the Board of Trustees.

C. HIGHLIGHTS

The more important developments since the 1994 Annual Report was issued are shown below:

• During calendar year 1994, OASDI benefits amounting to $316.8 billion were paid to retired and disabled workers and their families, and to survivors of deceased workers.
• The number of persons receiving monthly OASDI benefits at the end of December 1994 was 42.9 million.
• In 1994, an estimated 139 million people worked in jobs covered by the OASDI program and paid OASDI contributions on their earnings.
• Income to the combined OASI and DI Trust Funds amounted to $381.1 billion in calendar year 1994, and expenditures were $323.0 billion. The assets of the combined funds, therefore, increased by $58.1 billion, from $378.3 billion at the end of December 1993 to $436.4 billion at the end of December 1994.
• Assets at the beginning of the year, as a percentage of expenditures during the year, increased from 117 percent at the begin ning of 1994 to an estimated 128 percent at the beginning of 1995, for the combined OASI and DI Trust Funds.
• Interest earnings on the invested assets of the combined OASI and DI Trust Funds were $31.1 billion in calendar year 1994. This represented an effective annual interest rate of 8.0 percent, earned by the combined assets during calendar year 1994. During the same period, the average interest rate on new securities purchased by the trust funds was 7.1 percent.
• Administrative expenses for the OASDI program were $2.7 billion in calendar year 1994, or about 0.8 percent of benefit payments in the year.
• An automatic benefit increase of 2.8 percent became effective for December 1994. The OASDI contribution and benefit base was increased from $60,600 for 1994, to $61,200 for 1995.
• A greater portion of the OASDI tax rate was allocated to the DI Trust Fund effective retroactively with respect to wages paid after December 31, 1993, and to self-employment income for tax able years beginning after such date. This reallocation of tax rates changed the expected date of exhaustion of the DI Trust Fund from 1995 to 2016 under the `intermediate' set of assumptions of this report. The intermediate set of assumptions represents the Trustees' `best estimates' of likely future economic and demographic conditions.

The major findings of this report are summarized below:

• In the short range (i.e., the next 10 years) the combined assets of the OASI and DI Trust Funds are expected to increase from the current level of $436.4 billion, or 128 percent of annual expenditures, to $1,273 billion, or 230 percent of annual expenditures, at the beginning of the year 2004, based on the intermediate assumptions.
• The OASI Trust Fund is expected to increase rapidly during the next 10 years, from 139 percent of annual expenditures at the beginning of 1995 to about 246 percent of annual expenditures at the beginning of the year 2004, based on the intermediate assumptions.
• The DI Trust Fund is expected to increase rapidly for most of the next 10 years, rising from 54 percent of annual expenditures at the beginning of 1995 to 142 percent of annual expenditures at the beginning of 2003, based on the intermediate assumptions. While the assets of the fund, in nominal dollars, continue to grow during the entire short-range period consisting of the next 10 years, assets relative to annual expenditures begin to decline in 2003, becoming 140 percent at the beginning of 2004.
• In the long range (i.e., the next 75 years) income and expenditures are generally expressed as a percentage of the total amount of earnings subject to taxation under the OASDI program (referred to as `taxable payroll'). Summarized income and cost rates over the 75-year period are determined through present-value calculations and by taking into account actual beginning fund balances and targeted ending fund balances (or reserves) of 100 percent of annual expenditures.
• Overall, for the period 1995-2069, the difference between the summarized income and cost rates for the OASDI program is a deficit of 2.17 percent of taxable payroll based on the intermediate assumptions, slightly larger than the difference of 2.13 percent in last year's report.
• On a combined basis, the OASDI program is not in `close actuarial balance' over the next 75 years. (To be in close actuarial balance, the OASDI program must meet the long-range test described in the section entitled Actuarial Estimates later in this report.) In addition, the individual OASI and DI Trust Funds are not in close actuarial balance. These results are the same as those shown in the 1994 Annual Report.
• Income from OASDI payroll taxes represents 12.4 percent of taxable payroll--made up of the 6.2 percent tax rate paid by employees and a matching amount paid by their employers. (Self-employed workers pay OASDI taxes at the combined employee-employer rate.) Since these tax rates are not scheduled to change in the future under present law, OASDI payroll tax income as a percentage of taxable payroll remains constant at 12.4 percent.
• The income tax revenues that result from taxing up to one-half of the benefits are transferred to the OASI and DI Trust Funds and are currently equivalent to about 0.2 percent of taxable payroll. (Additional revenue resulting from taxing more than 50 percent, up to 85 percent, of benefits is transferred to the Hospital Insurance Trust Fund.) Adding the OASDI income from the taxation of benefits to the income from payroll taxes yields a total `income rate' of 12.6 percent. This total income rate is estimated to increase gradually to 13.3 percent of taxable payroll by the end of the 75-year projection period based on the intermediate assumptions. The growth is attributable, in part, to increasing proportions in both the number of beneficiaries and the amount of their benefits subject to taxation in the future. These proportions will increase because the income thresholds, above which benefits are taxable, are not indexed to future increases in average prices or average income.
• OASDI expenditures for benefit payments and administrative expenses currently represent about 11.5 percent of taxable payroll. This `cost rate' is estimated to remain below the corresponding income rate for the next 18 years, based on the intermediate assumptions. With the retirement of the `baby-boom' generation starting in about 2010, OASDI costs will increase rapidly relative to the taxable earnings of workers. By the end of the 75-year projection period, the OASDI cost rate is estimated to reach 19.0 percent under the intermediate assumptions, resulting in an annual deficit of about 5.7 percent.
• Expressed as a percentage of gross domestic product (GDP), the cost of the OASDI program is estimated to rise from its current level of 4.8 percent of GDP to 6.8 percent of GDP by the end of the 75-year projection period.
• Under the intermediate assumptions, the excess of OASDI tax revenues over expenditures for the next 18 years, together with interest earnings on the trust funds, will result in a rapid accumulation of assets for the combined OASI and DI Trust Funds during this period. However, total income is estimated to fall short of expenditures beginning in 2020 and continuing thereafter, under the intermediate assumptions. In this circumstance, trust fund assets would be redeemed to cover the difference. The assets of the combined OASI and DI Trust Funds are estimated to be depleted under present law in 2030 based on the intermediate assumptions.
• The assets of the trust funds are generally invested in special securities of the U.S. Treasury. The initial accumulation of assets will result in a substantial cash flow from the trust funds to the general fund of the Treasury, and the amount of special securities held by the combined trust funds will increase. The subsequent redemption of securities will cause this cash flow to reverse. The magnitude and pattern of these cash flows have important economic and public policy implications that extend beyond the operation of the OASDI program itself.
• Because the OASDI program is not in close actuarial balance, the long-range deficits of both the OASI and DI Trust Funds should be addressed. The Secretary of Health and Human Services has directed the current Advisory Council on Social Security to conduct an extensive review of Social Security financing issues and develop recommendations for restoring the long-range actuarial balance of the OASDI program.

D. TRUST FUND FINANCIAL OPERATIONS

The various sources of income to the OASDI program, and categories of expenditures, can be illustrated by reference to the actual transactions during calendar year 1994. The following table summarizes these transactions.

1. Income

Most OASDI income consists of the taxes paid by employees, employers, and the self-employed on earnings covered by the OASDI program. These taxes (also called contributions) represent a portion of the payroll taxes collected under the Federal Insurance Contributions Act (FICA) and the Self-Employment Contributions Act (SECA). The balance of the FICA and SECA contributions are used to finance the Hospital Insurance (HI) program, commonly referred to as `Part A' of Medicare. The taxes for the OASDI program are paid on earnings up to a specified maximum annual amount (the contribution and benefit base). Prior to 1994, HI taxes were also paid on earnings up to a maximum amount each year but are now paid on total covered earnings, without limitation. The following table shows the OASDI contribution and benefit base and the allocation of the FICA and SECA tax rates by program for 1995.

The tax rates for OASDI and for HI are not scheduled to change from their current values under present law. The maximum amount of earnings subject to OASDI taxes increases automatically each year, based on the increase in the average wage for all workers. In calendar year 1994, OASDI payroll tax income amounted to $344.7 billion, representing 90 percent of the total income received under the OASDI program during the year.

Beneficiaries whose adjusted gross income exceeds certain threshold amounts must pay income taxes on up to 85 percent of their annual OASDI benefits. The income tax revenue that results from taxing up to 50 percent of those benefits, together with taxes withheld from the benefits paid to non-resident aliens, is credited to the OASI and DI Trust Funds and totaled $5.3 billion in 1994. (The additional tax revenue that results from taxing up to 85 percent of benefits is credited to the HI Trust Fund.)

The final source of income to the trust funds is from interest on the invested assets of the funds. By law, these investments must be in interest-bearing securities of the U.S. Government or in securities guaranteed by the United States. Interest from investments in 1994 amounted to $31.1 billion.

2. Expenditures

In 1994, benefit payments totaling $316.8 billion were made to retired and disabled workers and their families, and to survivors of deceased workers. Such payments represent 98 percent of all expenditures by the OASDI program. An additional $3.5 billion was transferred from the OASI and DI Trust Funds to the Railroad Retirement program in 1994, under provisions of the law requiring a financial interchange between the two programs. The cost of administering the OASDI program in 1994 was $2.7 billion, or about 0.8 percent of total benefits paid during the year.

3. Trust Fund Assets

In 1994, total income was $381.1 billion and total expenditures were $323.0 billion. The assets of the OASI and DI Trust Funds therefore increased by a net total of $58.1 billion during the year, from $378.3 billion to $436.4 billion. The invested assets of the trust funds are backed by the full faith and credit of the U.S. Government, in the same way as other public-debt obligations of the United States.

If income to a trust fund is inadequate to defray expenditures, the fund's assets serve as a contingency reserve to cover the shortfall temporarily. For example, the expenditures of the DI Trust Fund exceeded income to the fund for most of 1994 (prior to enactment of the OASDI tax rate reallocation), necessitating a redemption of assets to cover the difference. In the event of recurring shortfalls, the availability of trust fund assets allows time for the enactment and implementation of legislation to restore financial stability to the program.

Conversely, when program income exceeds expenditures, the trust fund serves as a vehicle to help fund a portion of the program's accruing financial obligations in advance. In particular, as invested assets continue to increase over the next 20 to 30 years, interest earnings will become a larger share of total trust fund income. In 1994, interest income to the combined OASI and DI Trust Funds represented 8.2 percent of total OASDI income. On a combined basis, interest income in 2004 would represent an estimated 13.7 percent of total income.

E. INTRODUCTION TO ACTUARIAL ESTIMATES

The financial and actuarial status of the OASDI program is traditionally evaluated for both short range (the next 10 years) and long range (the next 75 years) periods. The various income and expenditure items described in the previous section are estimated separately, and then combined to form estimates of the future level of trust fund assets.

A period of 75 years is used to evaluate the long-range actuarial status of the program in order to obtain the full range of financial commitments that will be incurred on behalf of all current program participants. For example, a group of workers now entering the labor force at age 22 will work and pay OASDI taxes for the next 45 years before reaching age 67. At age 67, those surviving may retire and begin to receive full benefits (i.e., not reduced for early retirement). Some of them may live and receive benefits for more than 30 years. Thus, a 75-year projection period will include the entire working and retired life span of the great majority of workers now contributing to the program, as well as those now receiving benefits.

Because of the inherent uncertainty in estimates for as long as 75 years into the future, projections are shown in this report under three alternative sets of assumptions regarding future economic and demographic trends. Designated as alternatives I, II, and III, these sets range from low cost (alternative I) to high cost (alternative III), with alternative II representing the set of intermediate cost assumptions. The low cost set is more optimistic from the standpoint of OASDI financing and the high cost set is more pessimistic. In the tables in this report, the intermediate estimates, which the Board of Trustees regard as their `best estimates,' will be shown first followed by the low cost and high cost estimates.

From the estimated income, expenditure, and asset amounts, a number of different measures are calculated for use in evaluating the financial status of the program. Because of the difficulty in comparing dollar values for different periods, these measures are generally based on relative scales (although financial operations in nominal and inflation-adjusted dollar amounts are also available). These relative measures include (1) the annual amounts of future income and outgo as a percentage of the amount of earnings subject to the OASDI payroll tax, (2) the annual differences between these income and outgo figures, and (3) summarized values representing these figures over various periods. The level of trust fund assets relative to annual expenditures and the year in which the trust fund is projected to be exhausted are also presented as additional measures for evaluating the financial status of the program. Careful review of these measures provides a reasonably complete picture of the financial outlook for the OASDI program.

The program is also subject to two explicit tests of financial status (see section II.F)--a short-range test and a long-range test. The purpose of these tests is to provide objective criteria for determining whether or not the projected financial status of the OASDI program is considered satisfactory in each time period. The tests help highlight the need for corrective action when they are not met.

As usually required in the analysis of any complex subject, these summary tests should be considered in conjunction with a full understanding of the year-by-year patterns, trends, and other financial characteristics revealed by the underlying actuarial projections.

F. ECONOMIC AND DEMOGRAPHIC ASSUMPTIONS

Actual future income from OASDI payroll taxes and other sources, and actual future expenditures for benefits and administrative expenses, will depend upon a large number of factors: the size and composition of the population that is receiving benefits, the level of benefit amounts, the size and characteristics of the work force covered under OASDI, and the level of workers' earnings. These factors will depend in turn upon future marriage and divorce rates, birth rates, death rates, migration rates, labor force participation and unemployment rates, disability incidence and termination rates, retirement age patterns, productivity gains, wage increases, cost-of-living increases, and many other economic and demographic circumstances affecting the OASDI program.

While it is reasonable to assume that actual trust fund experience will fall within the range defined by the three alternative sets of assumptions used in this report, no definite assurance can be given that this will occur because of the uncertainty inherent in projections of this type and length. In general, a greater degree of confidence can be placed in the assumptions and estimates for the earlier years than for the later years. Nonetheless, even for the earlier years, the estimates are only an indication of the expected trend and general range of future program experience.

The assumptions vary, in most cases, from year to year during the first 5 to 25 years before reaching their ultimate values for the remainder of the 75-year projection period. The following table summarizes the ultimate values assumed for the key economic and demographic factors underlying the actuarial estimates shown in this report. These ultimate values apply for years after 2019, with the exception of life expectancy, which is assumed to continue improving throughout the projection period.

These key assumptions for this report are similar to the assumptions used in the 1994 report. The only significant change in any of the ultimate economic or demographic assumptions is an increase in the annual net immigration. The net number of other-than-legal immigrants assumed to enter the Social Security area population each year was increased by 50,000. This increase is consistent with estimates based on recent data from the Immigration and Naturalization Service.

Revisions of other economic and demographic assumptions for the early years of the projection period, based on data collected since the 1994 report, had little effect in the long range, with the exception of life expectancy and fertility. Data obtained since last year's report indicate that life expectancy in 1992 and 1993 was somewhat lower than was estimated a year ago. Projected values for life expectancy through the year 2070 are thus somewhat lower than estimated a year ago because the assumed ultimate rate of improvement in mortality was not changed for this report. Data for birth rates available since last year's report indicate slightly higher levels than were assumed a year ago. As a result, projected fertility rates are slightly higher for this year's report during the first 25 years, before the ultimate rates are attained. Taken alone, higher fertility rates for the first 25 years would result in a larger population throughout the 75-year period.

These assumptions reflect a careful assessment of past data and future prospects. No major changes in ultimate economic or demographic assumptions, other than those made for immigration, were deemed necessary to ensure that the financial projections continue to be based on the most plausible range of economic and demographic conditions. Other changes in assumptions and methods reflected in the estimates in this report are discussed in section II.F.

G. SHORT-RANGE ACTUARIAL ESTIMATES

The financial status of the OASDI program during the next 10 years (1995-2004) is measured by the estimated level of trust fund assets. Because of inflation, economic growth, and growth in the OASDI program, asset levels expressed in nominal dollar amounts are not comparable over long periods of time. For this reason, it is more informative to consider a relative measure of the program's financial condition.

For example, OASDI assets at the beginning of calendar year 1995 amounted to $436 billion, while assets at the beginning of 1960 were $22 billion. The asset level in 1995 would be sufficient to cover roughly 15 months of expenditures in the absence of other income. Assets in 1960, although much smaller in nominal dollars, could have covered about 22 months of expenditures and thus represented a somewhat stronger contingency reserve.

The ratio of trust fund assets at the beginning of a year to expenditures during the year is termed the `trust fund ratio.' This ratio serves as the primary measure of the fund's financial adequacy in the short range. It is also used when applying an explicit test of short-range financial adequacy.

1. OASI Trust Fund

The following chart presents historical trust fund ratios for the OASI Trust Fund in 1985-94 and estimated ratios for 1995-2004 based on the alternative sets of assumptions.

As shown in the chart, the OASI trust fund ratio is estimated to increase from 139 percent at the beginning of 1995 to 246 percent by 2004, based on the intermediate (alternative II) assumptions. The ratio is also estimated to increase during the next 10 years under both the low cost (alternative I) and high cost (alternative III) assumptions. Because OASI assets are estimated to exceed 100 percent of annual expenditures throughout the next 10 years, the OASI Trust Fund meets the requirements of the Trustees' formal test of short-range financial adequacy. (This test is described in detail in the section entitled Actuarial Estimates later in this report.) Thus, the financing scheduled under present law for the OASI Trust Fund is considered fully adequate to meet future expenditures over this period and to provide for an adequate contingency reserve.

2. DI Trust Fund

While the DI Trust Fund was not adequately financed in the short range under the estimates prepared for the 1994 Trustees Report, legislation enacted in 1994 provided additional financing to the DI Trust Fund through a reallocation of a portion of the OASI tax rate. As a result of this additional revenue, the DI Trust Fund now appears to be adequately financed for the immediate future. As shown in the following chart, the DI trust fund ratio is estimated to increase from 54 percent at the beginning of 1995 to 140 percent by 2004, based on the intermediate (alternative II) assumptions. Because DI assets are estimated to reach the level of 1 year's expenditures at the beginning of 1997 and remain above that level in 1998 and later, the DI Trust Fund meets the requirements of the Trustees' formal test of short-range financial adequacy under the intermediate cost assumptions.

However, as also shown in the chart, under the high cost assumptions, not only does DI fail to meet the short-range test of financial adequacy, the DI Trust Fund is projected to be exhausted near the end of the short-range projection period.

3. OASI and DI Trust Funds, Combined

The following chart summarizes the trust fund ratio for the OASI and DI Trust Funds, combined, in the recent past and estimates for the next 10 years.

As shown, the trust fund ratio for OASI and DI on a combined basis is estimated to increase from 128 percent at the beginning of 1995 to 230 percent by 2004, based on the intermediate assumptions. While the ratio would also increase throughout the 10-year period based on the low cost assumptions, it would begin to decline after the year 2000 under the high cost assumptions (but would remain above 100 percent throughout the short-range period). Because the trust fund ratio for the combined funds is estimated to remain above 100 percent under the intermediate assumptions, the combined funds meet the short-range test of financial adequacy.

H. LONG-RANGE ACTUARIAL ESTIMATES

The long-range financial estimates provided in this section generally relate to the OASI and DI Trust Funds on a combined basis. However, as the OASI and DI programs are legally separate, a final assessment of the financial status of these funds must be provided on a separate basis, as is done later in this section. More detailed estimates for these trust funds, both separately and combined, can be found in section II.F2 of this report.

Each year estimates of the financial and actuarial status of the OASDI program are prepared for the next 75 years. Although financial estimates for periods as long as 75 years are inherently uncertain, the results can provide valuable information for use by policymakers. In particular, such estimates can indicate whether the program--as seen from today's vantage point--is considered to be in satisfactory financial condition.

As mentioned previously, a number of different measures are useful in evaluating the financial status of the trust funds over the next 75 years. In addition to the actuarial balance and the trust fund ratio, emphasis is placed on the relationship between the levels of future tax income and future expenditures for each year (relative to the amount of earnings subject to the OASDI payroll tax). The year-by-year patterns of this relationship are of particular interest.

In addition to the presentation of long-range estimates, a specific test of the program's long-range financial status is applied. This test is referred to as the test for long-range close actuarial balance.

1. Annual Income Rates, Cost Rates, and Balances

The following chart compares past and estimated future OASDI income (from payroll taxes on covered earnings and income taxes on OASDI benefits) with OASDI expenditures (for benefits and administrative expenses). Included are historical data for the past 10 calendar years (1985-94) and estimates for the 75-year long-range projection period (1995-2069) under the three alternative sets of assumptions. The chart includes values through 2070, as do many of the long-range tables in the Actuarial Analysis section, in which values are presented for every fifth year of the long-range period and continue through 2070, thereby encompassing the full 75-year projection period which ends with 2069. These income and expenditure amounts are shown relative to the earnings in covered employment that are taxable under the OASDI program--referred to as taxable payroll. The ratio of tax income (including both payroll taxes and income from tax ation of benefits) to taxable payroll is called the income rate and the ratio of expenditures to taxable payroll is the cost rate.

For calendar year 1995, the income rate for the OASDI program is estimated to be about 12.58 percent of taxable payroll. This rate is made up of the combined tax rate payable by employees and employers, 12.40 percent, plus the revenue from the income taxation of OASDI benefits, equivalent to 0.18 percent of taxable payroll. Since OASDI payroll tax rates are not scheduled to change in the future under present law, payroll tax income as a percentage of taxable payroll remains constant at about 12.40 percent. Income from the taxation of benefits will gradually increase, primarily because a greater proportion of beneficiaries will become subject to taxation. Thus, the income rate is projected to increase somewhat from its current level, reaching about 13.33 percent of taxable payroll by the year 2070. The income rate projection shown in the chart is based on the intermediate set of assumptions (alternative II) only; the projections under the low cost and high cost sets of assumptions (alternatives I and III, respectively) are very similar.

As the chart indicates, the pattern followed by the estimated cost rates is much different. Costs as a percentage of taxable payroll are estimated to rise slowly for about 15 years (or to decline slowly, in the case of alternative I) and then to increase rapidly for about the next 20 years. Thereafter, cost rates are estimated to grow less rapidly (or to decline somewhat, in the case of alternative I). By the year 2070 the cost rate is estimated to have reached 13.09 percent, 19.04 percent, and 28.54 percent under alternatives I, II, and III, respectively.

The primary reason that the estimated OASDI cost rate increases rapidly after about 2010 is that the number of beneficiaries is projected to increase more rapidly than the number of covered workers. Because the cost rate expresses expenditures (primarily payments to beneficiaries) as a percentage of taxable payroll (the taxable earnings of covered workers), there is a close relationship between the demographic characteristics of the population and the OASDI cost rate.

The following chart shows the estimated number of covered workers per OASDI beneficiary. In 1994, there were about 3.3 workers for every beneficiary. As indicated, this ratio is expected to decline substantially in the future under all three sets of assumptions. Most of this decline will occur as the relatively large number of persons born during the baby boom (from the end of World War II through the mid-1960s) reaches retirement age and begins to receive benefits. At the same time, the relatively small number of persons born during the subsequent period of low fertility rates will comprise the labor force. Between 2030 and 2050, the number of workers per beneficiary is relatively stable as the baby boom generation diminishes in size. After the year 2050, this ratio will continue to decline at a slower pace for the intermediate and high cost projections, reflecting the increasing numbers of beneficiaries due to assumed increases in life expectancy. Based on the low cost assumptions, a slow increase in this ratio is projected to occur after 2050. By the end of the 75-year projection period, the number of workers per beneficiary is projected to decline to 2.5, 1.8, and 1.3 under the low cost (alternative I), intermediate (alternative II), and high cost (alternative III) assumptions, respectively.

The difference between the income rate and the cost rate in a given year is referred to as the annual balance for that year. The estimated pattern of the OASDI annual balance depends significantly on the economic and demographic conditions assumed to occur in the future. Income rates are estimated to exceed cost rates for the next 26, 18, and 4 years, under alternatives I, II, and III, respectively, resulting in positive annual balances. Thereafter, under the intermediate assumptions, the annual deficit would rise rapidly, reaching 2 percent of taxable payroll by 2020 and 5.71 percent in the year 2070. Under alternative I, a temporary period of deficits in excess of 1 percent of taxable payroll (from 2027 through 2037) would be followed by a return to relatively small deficits lasting throughout the remainder of the projection period. Under adverse conditions, as assumed in alternative III, the deficit would grow very rapidly, to nearly 15 percent of taxable payroll by the year 2070.

2. Summarized Income Rates, Cost Rates, and Balances

It is useful to consider the income and cost rates on a summarized basis over the three 25-year subperiods that make up the 75-year projection period. For this purpose, the annual income rates are summa rized by calculating the present value of future tax income for the period in question, and expressing it as a percentage of the present value of future taxable payroll for that period. (`Present values' are used in financial analysis to calculate the lump-sum equivalent value, at a particular point in time, of a series of future amounts or transac tions. See the Glossary for additional information.) Similarly, a summarized cost rate is calculated, based on the present value of future expenditures as a percentage of the present value of future taxable payroll. The following table shows these summarized amounts for the OASDI program for the three 25-year subperiods.

A surplus is shown under the intermediate alternative II assumptions for the first subperiod only; thereafter, the program is projected to experience substantial deficits, for the reasons outlined previously. Under the low cost alternative I assumptions, summarized tax income would exceed summarized costs for the first 25-year subperiod only, with deficits diminishing to relatively low levels in the third period. (The less favorable outlook for the second subperiod occurs under the low cost assumptions because the baby boom generation is retired essentially throughout this period, while the assumed higher ultimate fertility rates have not yet had their full effect on the estimated numbers of workers.) If the high cost conditions of alternative III are experienced, substantial deficits would occur for all three subperiods.

To assess the overall financial balance for the long range, it is customary to calculate summarized income rates and cost rates for the full 75-year period. For this purpose, summarized income and cost rates are calculated on a present-value basis, as before. In addition, the summarized income rate is augmented by the value of trust fund assets on hand at the beginning of the period. Similarly, the summarized cost rate is adjusted to include the additional cost of accumulating trust fund assets at the end of the period equal to 100 percent of the following year's expenditures. The results of this calculation are shown in the following table.

The difference between the summarized income and cost rates is called the actuarial balance and ranges from a surplus of 0.54 per cent of taxable payroll under the low cost assumptions to a deficit of 5.67 percent under the high cost assumptions. Based on the intermediate assumptions, an actuarial deficit of 2.17 percent is projected, representing the difference between the summarized income rate of 13.27 percent and the corresponding cost rate of 15.44 percent.

The estimated actuarial deficit is slightly larger than the corresponding deficit of 2.13 percent of payroll in last year's report. If the only change for this year's report were to change the long-range valuation period from 1994-2068 to 1995-2069, the deficit for this year's report would have risen to 2.20 percent of payroll. Thus, the net effect of updated assumptions and methods for this year's report was to slightly improve the financial status of the program on a year-by-year basis. See section II.F2g for complete details on the change in actuarial balance from last year's report.

The size of the actuarial balance for any period represents a measure of the program's financial adequacy for that period. The actuarial balance can be interpreted as the amount of change which, if made to the payroll tax rates scheduled under present law for each year in the period, would bring the program into exact actuarial balance. For example, if the 75-year actuarial deficit of 2.17 percent under intermediate assumptions were addressed by raising scheduled tax rates by 1.09 percent for employees and employers, each, and by 2.18 per cent for the self-employed, then OASDI assets at the beginning of 1995, together with income from payroll taxes, interest, and other sources, would be just sufficient to meet all expenditures for the period and leave a trust fund level at the end of the period equal to about 100 percent of the following year's expenditures. Of course, there are numerous other changes to tax rates or benefit provisions that could also result in the elimination of the long-range actuarial deficit.

The 75-year actuarial balance is a convenient and widely used measure of the OASDI program's overall financial status. It is important to remember, however, that this summary measure reflects the combined effects of several very different periods, as previously described. Thus, while the use of summary measures such as the actuarial balance is often convenient, such measures should not be used as a substitute for a more complete understanding of the underlying year-by-year outlook.

3. Trust Fund Ratios

As noted previously, the total income of the OASDI program currently exceeds total expenditures by a substantial margin. As a result, the assets of the combined trust funds are increasing rapidly. Under the intermediate alternative II assumptions, tax income is expected to exceed expenditures for about 12 years after the turn of the century, when the cost of the program will have started to increase with the retirement of the `baby-boom' generation. Thereafter, the tax rates scheduled in present law are expected to be insufficient to cover program expenditures and it will be necessary to use interest earned by the combined OASI and DI Trust Funds to make up the shortfall. Total income, including interest earnings, is expected to exceed expenditures through about 2019. Thereafter, it will be necessary to redeem assets to make up the shortfall. The resulting pattern of combined OASI and DI assets, expressed as a percentage of annual expenditures, is illustrated in the following chart under each of the three alternative sets of assumptions.

At the beginning of 1995, the combined assets of the OASI and DI Trust Funds represented about 128 percent of combined annual expenditures estimated for the year. Under alternatives I and II, this ratio would increase rapidly for at least the next 15 years. Based on the intermediate assumptions, assets would accumulate to a peak of 269 percent of expenditures in 2011, and would then decline steadily until exhaustion in the year 2030. Based on the intermediate estimates in last year's report, the peak fund ratio for the combined funds was estimated to be 241 percent and the year of exhaustion was estimated to be 2029. Even though the actuarial deficit is slightly larger than in last year's report, the year of exhaustion is later and the peak trust fund ratio is higher than in last year's report for the reasons indicated in the prior section.

For OASI and DI, separately, the peak fund ratios based on the intermediate assumptions are 311 and 142 percent, respectively, in this year's report and 361 percent and 23 percent, respectively, in last year's report. The reduction in the maximum fund ratio for OASI, as well as the increase for DI, results largely from the tax rate reallocation enacted since last year's report. The following table summarizes the projections in this year's report for OASI, DI, and the combined trust funds under the three sets of assumptions for the period 1995 through 2070.

Under the low cost alternative I assumptions, the trust fund ratio roughly levels off during the retirement years of the baby boom generation, but resumes increasing by 2040, even though annual balances are negative. This occurs because the assumed trust fund interest rates are high enough to offset the small annual deficits and still keep the trust funds growing faster than annual outgo. For the high cost alternative III, the combined trust fund is permanently exhausted in 2016.

Trust fund assets are generally invested in special Treasury securities so that the excess of cash receipts over expenditures are borrowed from the trust funds by the general fund of the Treasury and used to help meet various Federal outlays. These securities are backed by the full faith and credit of the U.S. Government, the same as other public-debt obligations of the U.S. Government. The assets of the trust funds can be redeemed for cash at any time if required to meet program expenditures. The redemption of a Treasury security held by a trust fund requires that the Treasury transfer cash--obtained from another revenue source, such as income taxes or borrowing from the public--to the trust fund. Thus, the investment operations of the trust funds result in various cash flows between the trust funds and the general fund of the Treasury.

Under the intermediate assumptions, the excess of OASDI income over outgo during the next 18 years will result in a substantial net cash flow from the trust funds of amounts borrowed by the general fund. Thereafter, this cash flow is expected to reverse; as trust fund securities are redeemed to meet benefit payments and other expenditures, revenue from the general fund of the Treasury will be drawn upon to provide the necessary cash. The accumulation and subsequent redemption of substantial trust fund assets has important economic and public policy implications that go well beyond the operation of the OASDI program itself. Discussion of these broader issues is not within the scope of this report.

4. Test of Long-Range Close Actuarial Balance

Because the OASI and DI programs, both separately and combined, have actuarial deficits that are more than 5 percent of the corresponding summarized cost rates over the next 75 years under the Trustees' intermediate (alternative II) assumptions, they do not meet the requirements of the Trustees' formal test for long-range close actuarial balance. (This test is described in detail in the section entitled Actuarial Estimates later in this report.)

I. CONCLUSION

The combined OASI and DI Trust Funds are adequately financed over the next 10 years, and for many years thereafter. At the beginning of 1995, the combined assets of the trust funds represented 128 percent of combined expenditures for 1995. The combined funds are projected to continue to grow during the next 10 years, and for many years thereafter, under both the intermediate and low cost assumptions. However, while the assets of the combined funds, in nominal dollars, continue to grow under the high cost assumptions for the next 10 years, 1995 through 2004, the trust fund ratio of assets to annual expenditures begins to decline in 2000.

The OASI Trust Fund is expected to grow rapidly during the next 10 years from a current level of 139 percent of annual outgo to about 2.5 times annual outgo by the year 2004, based on the intermediate assumptions. Thus, the OASI Trust Fund meets the criteria for financial adequacy in the short range by a wide margin.

The DI Trust Fund is also adequately financed over the next 10 years. Outgo from the DI Trust Fund exceeded income in both 1992 and 1993. However, these declines were reversed by the reallocation of part of the OASI contribution rate to DI that was enacted in 1994. The assets of the DI fund, in nominal dollars, are now expected to rise throughout the next 10 years, based on both the intermediate and low cost assumptions. The ratio of assets to expenditures is expected to increase from 54 percent at the beginning of 1995 to 142 percent by the beginning of 2003 and then to decline to 140 percent at the beginning of 2004, based on the intermediate assumptions.

Although the combined trust funds are well financed over the first 10 years and are expected to continue growing, in nominal dollars, for the first 25 years under the intermediate assumptions, the OASDI program is not in close actuarial balance over the next 75 years, based on these assumptions. The estimates indicate that the combined trust funds would be sufficient to enable the timely payment of benefits for the next 35 years. Relative to annual expenditures, the combined trust funds would continue to grow during the next 16 years, reaching a peak of about 2.7 times annual expenditures. Considering each fund separately, the OASI Trust Fund would have sufficient funds for the next 36 years, and the DI Trust Fund would be sufficient for the next 21 years. On the basis of the high cost assumptions, the combined funds would be sufficient to enable timely payment of benefits for about the next 21 years. Based on the low cost assumptions, the combined funds would continue to grow throughout the next 75 years, and they would be sufficient to enable timely payment of benefits during all of the long-range period.

For each of the next 18 years, OASDI income from payroll taxes and income taxes on benefits is expected to exceed total expenditures based on the intermediate assumptions. Starting about 14 years from now, however, OASDI costs as a percentage of taxable payroll are projected to begin increasing rapidly as the annual balances become negative after the first 18 years, the availability of interest earnings, in addition to tax revenues, results in projected trust fund growth (in dollars) that would continue for another 7 years. Because expenditures are estimated to increase at a faster rate than assets, however, OASDI assets would decline relative to annual disbursements, from about 2.7 times to about 2.0 times annual expenditures, during the same time period.

The Advisory Council on Social Security is conducting an extensive review of Social Security financing issues, and the Board looks forward to receiving the Council's recommendations for restoring the long-range actuarial balance of the OASDI program.