2007 OASDI Trustees Report

II. OVERVIEW

D. PROJECTIONS OF FUTURE FINANCIAL STATUS

Short-Range Actuarial Estimates

For the short range (2007-2016), the Trustees measure financial adequacy by comparing assets at the beginning of each year to projected program cost for that year under the intermediate set of assumptions. Having a trust fund ratio of 100 percent or more-that is, assets at the beginning of each year at least equal to projected cost for the year-is considered a good indication of a trust fund's ability to cover most short-term contingencies. Both the OASI and the DI trust fund ratios under the intermediate assumptions exceed 100 percent throughout the short-range period and therefore satisfy the Trustees' short-term test of financial adequacy. Figure II.D1 below shows that the trust fund ratios for the combined OASI and DI Trust Funds reach a peak level in 2014 and begin declining thereafter.

Figure II.D1.-Short-Range OASDI Trust Fund Ratios

[Assets as a percentage of annual expenditures]

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Long-Range Actuarial Estimates

The financial status of the program over the next 75 years is measured in terms of annual cost and income as a percentage of taxable payroll, trust fund ratios, the actuarial balance (also as a percentage of taxable payroll), and the open group unfunded obligation (expressed in present-value dollars). Considering Social Security's cost as a percentage of the total U.S. economic output (gross domestic product or GDP) provides an additional perspective.

The year-by-year relationship between income and cost rates shown in figure II.D2 illustrates the expected pattern of cash flows for the OASDI program over the full 75-year period. Under the intermediate assumptions, the OASDI cost rate is projected to decline slightly in 2008 and then increase up to the 2007 level within the next 2 years. It then begins to increase rapidly and first exceeds the income rate in 2017, producing cash-flow deficits thereafter. Cash-flow deficits are less than trust fund interest earnings until 2027. Redemption of trust fund assets will allow continuation of full benefit payments on a timely basis until 2041, when the trust funds will become exhausted. This redemption process will require a flow of cash from the General Fund of the Treasury. Pressures on the Federal Budget will thus emerge well before 2041. Even if a trust fund's assets are exhausted, however, tax income will continue to flow into the fund. Present tax rates would be sufficient to pay 75 percent of scheduled benefits after trust fund exhaustion in 2041 and 70 percent of scheduled benefits in 2081.

Figure II.D2.-OASDI Income and Cost Rates Under Intermediate Assumptions

[As a percentage of taxable payroll]

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Social Security's cost rate generally will continue rising rapidly through about 2030 as the baby-boom generation reaches retirement eligibility age. Thereafter, the cost rate is estimated to rise at a slower rate for about 5 years and then stabilize for the next 15 years as the baby-boom ages and decreases in size. Continued reductions in death rates and maintaining birth rates at levels well below those from the baby-boom era and before will cause a significant upward shift in the average age of the population and will push the cost rate from 17.3 percent of taxable payroll in 2050 to 18.5 percent by 2081 under the intermediate assumptions. In a pay-as-you-go system (with no trust fund assets or borrowing authority), this 18.5-percent cost rate means the combination of the payroll tax (scheduled to total 12.4 percent) and proceeds from income taxes on benefits (expected to be 0.9 percent of taxable payroll in 2081) would have to equal 18.5 percent of taxable payroll to pay all currently scheduled benefits. After 2081, the upward shift in the average age of the population is likely to continue and to increase the gap between OASDI costs and income.

The primary reason that the OASDI cost rate will increase rapidly between 2010 and 2030 is that, as the large baby-boom generation born in the years 1946 through 1965 retires, the number of beneficiaries will increase much more rapidly than the number of workers. The estimated number of workers per beneficiary is shown in figure II.D3. In 2006, there were about 3.3 workers for every OASDI beneficiary. The baby-boom generation will have largely retired by 2030, and the projected ratio of workers to beneficiaries will be only 2.2 at that time. Thereafter, the number of workers per beneficiary will slowly decline, and the OASDI cost rate will continue to increase largely due to projected reductions in mortality.

Figure II.D3.-Number of Covered Workers Per OASDI Beneficiary

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The maximum projected trust fund ratios for the OASI, DI, and combined funds appear in table II.D1. The year in which the maximum projected trust fund ratio is attained and the year in which the assets are projected to be exhausted are shown as well.

The actuarial balance is a measure of the program's financial status for the 75-year valuation period as a whole. It is essentially the difference between income and cost of the program expressed as a percentage of taxable payroll over the valuation period. This single number summarizes the adequacy of program financing for the period. When the actuarial balance is negative, the actuarial deficit can be interpreted as the percentage that could be added to the current law income rate for each of the next 75 years, or subtracted from the cost rate for each year, to bring the funds into actuarial balance. Because the timing of any future changes is unlikely to follow this pattern, this measure should be viewed only as providing a rough indication of the average change that is needed over the 75-year period as a whole. In this report, the actuarial balance under the intermediate assumptions is a deficit of 1.95 percent of taxable payroll for the combined OASI and DI Trust Funds. The actuarial deficit was 2.02 percent in the 2006 report and has been in the range of 1.86 percent to 2.23 percent for the last ten reports.

Another way to illustrate the financial shortfall of the OASDI system is to examine the cumulative value of taxes less costs, in present value. Figure II.D4 shows the present value of cumulative OASDI taxes less costs over the next 75 years. The balance of the combined trust funds peaks at $2.6 trillion in 2017 (in present value) and then turns downward. This cumulative amount continues to be positive, indicating trust fund assets, or reserves, through 2040. However, after 2040 this cumulative amount becomes negative, indicating a net unfunded obligation. Through the end of 2081, the combined funds have a present-value unfunded obligation of $4.7 trillion. This unfunded obligation represents 1.8 percent of future taxable payroll and 0.7 percent of future GDP, through the end of the 75-year projection period.

Figure II.D4.-Cumulative OASDI Income Less Cost, Based on Present Law Tax Rates and Scheduled Benefits

[Present value as of January 1, 2007, in trillions]

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Still another important way to look at Social Security's future is to view its cost as a share of U.S. economic output. Figure II.D5 shows that Social Security's cost as a percentage of GDP will grow from 4.3 percent in 2007 to 6.2 percent in 2030, and then slightly increase to 6.3 percent in 2081. However, Social Security's scheduled tax income is projected to be about 4.9 percent of GDP in both 2007 and 2030, and then to decrease to 4.5 percent in 2081. Income from payroll taxes declines generally in relation to GDP in the future because an increasing share of employee compensation is assumed to be provided in fringe benefits, making wages a shrinking share of GDP. Between 2010 and 2030, however, the total non-interest income does not decline as a percent of GDP because benefits, and thus income to the trust funds from taxation of these benefits, are rising rapidly as a percent of GDP during the period.

Figure II.D5.-OASDI Cost and Scheduled Tax Revenue as a Percentage of GDP

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Consideration of a 75-year period is not enough to provide a complete picture of Social Security's financial condition. Figures II.D2, II.D4, and II.D5 show that the program's financial condition is worsening at the end of the period. Overemphasis on summary measures for a 75-year period can lead to incorrect perceptions and to policy prescriptions that do not achieve sustainable solvency. Thus, careful consideration of the trends in annual deficits and unfunded obligations toward the end of the 75-year period is important. In addition, summary measures for a time period that extends to the infinite horizon are included in this report. These measures provide an additional indication of Social Security's very long-run financial condition, but are subject to much greater uncertainty. These calculations show that extending the horizon beyond 75 years increases the unfunded obligation. Over the infinite horizon, the shortfall (unfunded obligation) is $13.6 trillion in present value, or 3.5 percent of future taxable payroll and 1.2 percent of future GDP. These calculations of the shortfall indicate that much larger changes may be required to achieve solvency beyond the 75-year period as compared to changes needed to balance 75-year period summary measures. The measured unfunded obligation over the infinite horizon increases from $13.4 trillion in last year's report to $13.6 trillion in this report. In the absence of any changes in assumptions, methods, and starting values, the unfunded obligation over the infinite horizon would have risen to $14.1 trillion due to the change in the valuation date.

Changes From Last Year's Report

The long-range OASDI actuarial deficit of 1.95 percent of taxable payroll for this year's report is smaller than the deficit of 2.02 percent of taxable payroll shown in last year's report under intermediate assumptions. Changes in methodology and assumed rates of disability incidence are the main reasons for the decrease in the deficit. For a detailed description of the specific changes identified in table II.D2 below, see section IV.B.7.

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

The open group unfunded obligation over the 75-year projection period has increased from $4.6 trillion (present discounted value as of January 1, 2006) to $4.7 trillion (present discounted value as of January 1, 2007). The measured increase in the unfunded obligation would be expected to be about $0.3 trillion due to advancing the valuation date by 1 year and including the additional year 2081. Changes in methods and assumptions offset most of this expected increase.

Figure II.D6 shows that this year's projections of annual balances are generally higher than those in last year's report principally because of the changes in methods and assumptions. Annual balances are similar between the two reports through about 2030. Thereafter, annual balances are somewhat higher for the rest of the long-range projection period. Section IV.B.7 provides a detailed presentation of these changes.

Figure II.D6.-OASDI Annual Balances: 2006 and 2007 Trustees Reports

[As a percentage of taxable payroll under the intermediate assumptions]

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Uncertainty of the Projections

Significant uncertainty surrounds the intermediate assumptions. The Trustees have traditionally used low cost (alternative I) and high cost (alternative III) assumptions as an indication of this uncertainty. Figure II.D7 shows the projected trust fund ratios for the combined OASI and DI Trust Funds under the intermediate, low cost, and high cost assumptions. The low cost alternative is characterized by assumptions that improve the financial condition of the trust funds, including a higher fertility rate, slower improvement in mortality, a higher real-wage differential, and lower unemployment. The high cost alternative, in contrast, features a lower fertility rate, more rapid declines in mortality, a lower real-wage differential, and higher unemployment. While it is extremely unlikely that all of these parameters would move in the same direction over the 75-year period relative to the intermediate projections, there is a not-insignificant-though quite low-probability that the actual outcome for future costs could be as extreme as either of the outcomes portrayed by the low and high cost projections. The method for constructing these high and low cost projections does not allow for the assignment of a specific probability to the likelihood that actual experience will lie within or outside the range they entail. However, an alternative approach to illustrating the uncertainty inherent in such long-term projections discussed in Appendix E suggests that the low and high cost projections bound a range that encompasses something on the order of 95 percent of possible future financial outcomes. Given there is an equal probability that the actual outcome will be either more or less favorable than that portrayed by the intermediate cost projection, this implies that there is something on the order of only a 2.5 percent probability that it will be as favorable as that portrayed by the low cost projection or as unfavorable as that portrayed by the high cost projection.

Figure II.D7.-Long-Range OASDI Trust Fund Ratios Under Alternative Assumptions

[Assets as a percentage of annual cost]

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