Trustees Report- 1996

D. PRINCIPAL ECONOMIC AND DEMOGRAPHIC ASSUMPTIONS

The future income and outgo of the OASDI program depend on many economic and demographic factors, including gross domestic product, labor force, unemployment, average earnings, productivity, inflation, fertility, mortality, net immigration, marriage, divorce, retirement patterns, and disability incidence and termination. The income will depend on how these factors affect the size and composition of the working population and the level and distribution of earnings. Similarly, the outgo will depend on how these factors affect the size and composition of the beneficiary population and the general level of benefits.

Because precise prediction of these various factors is impossible, estimates are shown in this report on the basis of three sets of assumptions, designated as intermediate (alternative II), low cost (alternative I), and high cost (alternative III). The intermediate set, alternative II, represents the Board's best estimate of the future course of the population and the economy. In terms of the net effect on the status of the OASDI program, the low cost alternative I is the more optimistic, and the high cost alternative III is the more pessimistic of the plausible economic and demographic conditions.

The values assumed after the first 5 to 25 years for both the economic and the demographic factors are intended to represent the average experience and are not intended to be exact predictions of year-by-year values. Actual future values will likely exhibit fluctuations or cyclical patterns, as in the past.

Although these sets of economic and demographic assumptions have been developed using the best available information, the resulting estimates should be interpreted with care. In particular, the resulting estimates are not intended to be exact predictions of the future status of the OASDI program, but rather, they are intended to be indicators of the trend and range of future income and outgo, under a variety of plausible economic and demographic conditions.

1. Economic Assumptions

The principal economic assumptions for the three alternatives are summarized in table II.D1.

Alternatives I, II, and III present a range of generally consistent sets of economic assumptions which have been designed to produce variation in Social Security's financial status that should encompass most of the possibilities that might be encountered. The intermediate set of assumptions (alternative II) represents the Trustees' consensus expectation of moderate economic growth throughout the projection period. The low cost assumptions (alternative I) represent a more optimistic outlook, with relatively strong economic growth projected during the short-range period and tapering off a little during the long-range period. The high cost assumptions (alternative III) represent a relatively pessimistic forecast in which the economy experiences generally weak economic growth and business cycles with two recessions in the short-range period. Economic cycles are not included in assumptions beyond the first 5 to 10 years of the projection period because inclusion of such cycles has little effect on the long-range estimates of financial status.

A period of sustained real economic growth began in 1982 and ended with the recession that started with the third quarter of 1990. After a total decline in real GDP of 2.2 percent through the first quarter of 1991, and three quarters of slow growth following the recession, the return to steady economic growth which began in 1992 is assumed to continue for alternatives I and II, albeit at a somewhat slower pace. For the short-range period (1996-2005), average annual real GDP growth is assumed to be about 2.7 percent for alternative I and 2.0 percent for alternative II.

For alternative III, weak growth and an increasing rate of price inflation are assumed for the first quarter of 1996. The first projected recession begins in the second quarter of 1996, lasts 3 quarters, and results in a total decline in real GDP of 1.4 percent. After 8 quarters of recovery, a second recession, with a total decline in real GDP of 3.0 percent, is assumed to begin in the first quarter of 1999, lasting 4 quarters. After the second recession, a moderate economic recovery is assumed through the year 2002.

After the year 2005, the projected rates of growth in real GDP, for all three alternatives, are determined by the assumed rates of growth in employment, average hours worked, and labor productivity. The trend toward slower growth in real GDP after 2005 results primarily from much slower growth in the working age population, as the baby-boom generation approaches retirement and succeeding generations reflecting lower birth rates reach working age. The slowdown in the growth rate in real GDP also reflects the assumed leveling of labor force participation rates for women, which have risen substantially over the past 20 years, and the continuation of the historical downward trend of labor force participation rates among men in the future. The annual rate of growth in total labor force decreased from 2.3 percent in 1994 to 0.9 percent in 1995. After 1995 the labor force is projected to increase at about 0.9 percent per year, on average, through 2002, and to increase more slowly thereafter, reflecting the projected slowing of growth of the working-age population as compared with the experience of the 1980s and early 1990s.

Since last year's report, the Bureau of Economic Analysis has changed from a fixed-weighted to a chain-weighted price measure for the purpose of calculating the real-growth component of GDP and has revised the historical values of real GDP growth over the period 1959-94. While the data shown in table II.D1 for historical years reflect these revisions, the projected growth rates in real GDP for years after 1995 do not reflect changes in methodology. The analysis necessary to fully incorporate the implications of the revisions will be completed for the next report.

The age-sex adjusted unemployment rate, for alternatives I and II, is assumed to move gradually toward ultimate average levels of 5.0 and 6.0 percent, respectively, by 2006. For alternative III, the age-sex-adjusted unemployment rate is assumed to reach its ultimate average level of 7.0 percent by 2006, after a recovery that is assumed to follow the projected recession in 1999.

Unemployment rates through 2005 are in the most commonly cited form, the civilian rate, which describes the differences between aggregate civilian labor force and aggregate civilian employment. For years after 2005, however, total rates are presented. These include the military (which reduces the rate by about 0.1 percent relative to the civilian rate) and are age-sex adjusted to the 1994 labor force. Such total rates better represent the total population covered by the OASDI program and adjust for the changing age-sex distribution of the labor force, which can obscure the comparison of unemployment rates over different time periods.

Unemployment rates for the years 1994 and later are based on the new survey methodology used by the Bureau of Labor Statistics. Though unemployment rates based on this new method were initially expected to be about 0.5 percentage point higher than if based on the old method, comparisons for 1994 have shown little or no difference.

For the intermediate projection, each of the other economic parameters is selected reflecting what the Trustees believe to be the most likely future course of the economy at the time of preparation of this report, consistent with the assumed pattern of real GDP growth. The annual rate of change in the average wage in covered employment is assumed to rise, generally, from the estimated 4.1 percent increase for 1995, averaging about 4.5 percent for the period 1996 through 2005. Growth in the average wage (which is equal to price inflation plus the real-wage differential) through 2005 averages somewhat less than the ultimate assumed rate of 5.0 percent primarily because price inflation averages less than its ultimate level through this period. Between 2005 and 2020, growth in the average covered wage is slightly higher than the assumed ultimate rate of 5.0 percent, reflecting the gradual movement toward complete inclusion of Federal civilian employees. After 2020, the average covered wage growth rate remains at the ultimate assumed rate of 5.0 percent.

The annual rate of increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) was 2.9 percent in 1995. For alternative II, the CPI-W (hereinafter denoted as "CPI") is assumed to increase 2.7 percent in 1996 and 3.2 percent in 1997, moving toward the assumed ultimate rate of 4.0 percent by 2003. For alternative I, the CPI is projected to increase 2.4 percent in 1996 and 2.8 percent in 1997, moving toward the assumed ultimate rate of 3.0 percent by 1998. For alternative III, the CPI is projected to increase from a relatively low 2.7 percent in 1996 to a relatively high 5.4 percent in 1998 and 1999, eventually stabilizing at the assumed ultimate rate of 5.0 percent in 2001. Recent and expected future changes by the Bureau of Labor Statistics to correct the "formula bias" in the CPI have not been reflected in assumptions for future price inflation in this report. The analysis necessary to reflect these changes, along with those recently made by the Bureau of Economic Analysis in the methodology used in measuring real GDP growth, will be completed for the 1997 report.

The real-wage differential (i.e., the difference between the annual rates of change in the average wage in covered employment and in the CPI) is estimated to be 1.2 percent in 1995. After 1995, under the intermediate alternative, the real-wage differential is projected to be between 0.7 and 1.3 percent for the years 1996 through the year 2020, thereafter remaining at the ultimate assumed differential of 1.0 percent. For the low cost alternative I, the real-wage differential is assumed to be in the range of 1.5 percent to 1.8 percent between 1996 and 2020, thereafter remaining at the ultimate assumed real-wage differential of 1.5 percent. For the high cost alternative III, a more pessimistic real-wage differential is assumed for the short-range period, averaging 0.2 percent per year. After 2030, the real-wage differential is assumed to be 0.5 percent per year for alternative III.

Under the intermediate alternative, the average annual interest rate for securities newly issued to the trust funds is assumed to decrease from 6.9 percent in 1995 to 6.4 percent for 1996, and remain around 6.5 percent until 2004. After 2005, the average annual interest rates are assumed to be 6.0, 6.3, and 6.5 percent for alternatives I, II, and III, respectively.

For alternatives I and III, respectively, values for each of the economic parameters are selected to generally reflect a more optimistic and a more pessimistic future financial status of the program. Some of the parameters would normally be expected to deviate in opposite directions from the values assumed for the intermediate alternative. Thus, alternatives I and III also assume structural economic shifts in the relationships among parameters which tend toward low cost and high cost, respectively.

2. Demographic Assumptions

The principal demographic assumptions for the three alternatives are shown in table II.D2.

For the intermediate projection, the assumed ultimate total fertility rate of 1.9 children per woman is attained in 2020 after a gradual decline from the preliminary estimate for 1995 of 2.04 children per woman. The age-sex-adjusted death rate is assumed to decrease steadily during the entire projection period, with a total reduction of 36 percent from the 1995 level by 2070. Life expectancies at birth in 2070 are 78.4 years for men and 84.1 years for women, compared to 72.3 and 79.2 years, respectively, in 1995. Life expectancies at age 65 in 2070 are projected to be 18.4 years for men and 22.2 years for women, compared to 15.4 and 19.2 years, respectively, in 1995. The projected death rates reflect the effects of assumed cases of Acquired Immunodeficiency Syndrome (AIDS), using estimates prepared by the Centers for Disease Control and Prevention (CDC) as a starting point. Total net immigration is assumed to rise over the next several years reaching an ultimate level of 900,000 persons per year by the year 2000. The ultimate assumed level of net annual immigration is the combination of 600,000 net legal immigrants per year and 300,000 net other-than-legal immigrants per year.

For the low cost alternative I, the total fertility rate is assumed to rise to an ultimate average level of 2.2 children per woman by 2020. The age-sex-adjusted death rate is assumed to decrease more slowly than for the intermediate alternative II, with the total reduction from the 1995 level being 16 percent by 2070. Life expectancies at birth in 2070 are 75.6 years for men and 81.1 years for women, while at age 65 they are 16.2 and 19.7 years, respectively. Total net immigration is ultimately assumed to be 1,150,000 persons per year. The assumed level of net annual immigration is the combination of 700,000 net legal immigrants per year and 450,000 net other-than-legal immigrants per year.

For the high cost alternative III, the total fertility rate is assumed to decrease to an ultimate level of 1.6 by 2020. The age-sex-adjusted death rate is assumed to decrease more rapidly than for alternative II, with the total reduction from the 1995 level being 55 percent by 2070. Life expectancies at birth in 2070 are 82.3 years for men and 88.0 years for women, while at age 65 they are 21.4 and 25.4 years, respectively. Total net immigration is ultimately assumed to be 750,000 persons per year, the combination of 550,000 net legal immigrants per year and 200,000 net other-than-legal immigrants per year.

In addition to the assumptions discussed above, many other factors are necessary to prepare the estimates presented in this report. Section II.H includes a discussion of many of those factors.

The ultimate values presented in table II.D2 reflect little change from the ultimate values used for last year's report. The ultimate rates of change in mortality for the age groups under 65 were increased for this report so that they would be higher than the ultimate rates of change for older groups, consistent with historical experience throughout this century. In addition, ultimate net immigration rates were redistributed by increasing other-than-legal and decreasing legal net immigration. The decrease of 50,000 legal immigrants reflects the lower numbers currently being admitted by the Immigration and Naturalization Service (INS). The increase of 50,000 other-than-legal immigrants is based on continuing studies done by INS and the Bureau of the Census which show increasing numbers of illegal immigrants. The effect on the financing of the OASDI program of these and other changes is discussed in section II.F2.