CHAPTER
3
The Long-Term Outlook for Social Security
Social Security is the federal government’s largest nondefense program. Created in 1935, the program now consists of two parts: Old-Age and Survivors Insurance pays benefits to retired workers and to their dependents and survivors; and Disability Insurance (DI) makes payments to disabled workers who are younger than the normal retirement age and to their dependents. In all, about 52 million people are receiving Social Security benefits. The Congressional Budget Office projects that outlays for that program in fiscal year 2009 will total $670 billion, or roughly one-sixth of the federal budget.
During the program’s first four decades, spending for Social Security steadily increased relative to the size of the economy, reaching about 4 percent of gross domestic product in the mid-1970s. That increase was driven largely by repeated expansions of the program. The costs spiked up to nearly 5 percent of GDP in the early 1980s, a period that coincided with the last major piece of Social Security legislation. Since then, spending for Social Security has fluctuated between 4.2 percent and 4.6 percent of GDP, accounting for 4.3 percent of GDP in fiscal year 2008 (see Figure 3-1). CBO projects that spending for this program will grow to almost 5 percent of GDP this year as outlays increase and GDP contracts. CBO anticipates that spending for Social Security will reach 6.0 percent of GDP by 2035 and remain close to that figure in succeeding decades.
Spending for Social Security, 1962 to 2080
(Percentage of gross domestic product)
Source: Congressional Budget Office.
In general, workers are eligible for retirement benefits if they are age 62 or older and have paid sufficient Social Security taxes for at least 10 years.1 Workers whose employment has been limited because of a physical or mental disability can become eligible for DI benefits at an earlier age and, in many cases, with a shorter employment history. Various rules for determining eligibility and benefit amounts apply to family members of retired, disabled, or deceased workers.
When retired or disabled workers first claim Social Security benefits, the initial payments they receive are based on their average lifetime earnings. The formula used to translate average earnings into benefits is progressive; that is, it replaces a larger share of preretirement earnings for people with lower average earnings than it does for people with higher earnings. The benefit formula and individuals’ earnings histories are indexed to changes in average annual earnings for the labor force as a whole.2 Because average national earnings generally grow at a faster rate than does inflation, that indexation causes initial benefits for future recipients to grow in real (inflation-adjusted) terms. Benefits are also subsequently adjusted to reflect annual changes in consumer prices.
For retirement benefits, a final adjustment is made on the basis of the age at which a recipient chooses to start claiming benefits: The longer a person waits (up to age 70), the higher the benefits will be. That final adjustment is intended to be “actuarially fair,” so that an individual’s total lifetime benefits will have an approximately equal value regardless of when he or she begins collecting them.
For workers born before 1938, the age of eligibility for full retirement benefits—referred to as Social Security’s normal retirement age—is 65. Under current law, that age is gradually increasing and will be 67 for people born in 1960 or later. Specifically, the normal retirement age rose by two months per birth year for people born between 1938 and 1943, remains at 66 for those born between 1944 and 1954, and then begins to increase again by two months per birth year for people born between 1955 and 1960. The age at which workers may start receiving reduced benefits—age 62—remains the same.
The Social Security Administration estimates that workers who retire at age 65 in 2009 and who had average annual earnings throughout their career will be eligible for an annual benefit of almost $17,000. That amount will replace about 40 percent of their preretirement earnings. In later decades, the replacement rate will be lower for workers with average earnings who retire at age 65, mainly because of the scheduled increase in the normal retirement age. Nevertheless, initial benefits are indexed to average wages, which grow over time, and the real value of those benefits will therefore continue to rise.
Although Social Security is commonly thought of as a retirement program, it also provides other types of benefits. Indeed, only about 64 percent of its beneficiaries receive their payments as retired workers (see Figure 3-2). As of April 2009, 15 percent of beneficiaries were disabled workers, 13 percent were survivors of deceased workers, and the remaining 9 percent were spouses or children of retired or disabled workers.
Distribution of Social Security Beneficiaries, by Type of Benefits Received, April 2009
Source: Congressional Budget Office based on Social Security Administration, “Monthly Statistical Snapshot, April 2009,” Table 2.
The Social Security program has two sources of dedicated tax revenues. The main source is a payroll tax of 12.4 percent of earnings, split evenly by workers and their employers. Only earnings up to a maximum annual amount ($106,800 in 2009) are subject to the payroll tax. That amount—the taxable earnings base—is adjusted each year for changes in average earnings in the U.S. economy unless the cost-of-living adjustment is zero, in which case it remains unchanged.3 The other, smaller source, which was equal to about 3 percent of payroll tax revenues in 2008, is the income taxes that higher-income beneficiaries pay on their benefits. Revenues from both sources, along with intragovernmental interest payments, are credited to the program’s trust funds. Social Security benefits, the program’s administrative costs, and other authorized expenditures are paid from those funds.
The Outlook for Social Security Spending and Revenues
The cost of the Social Security program will rise noticeably in coming decades—a change that has long been foreseen. Average benefits typically grow when the economy does, because the earnings on which those benefits are based increase.4 In the future, however, changes in the nation’s demographic structure will cause the total amount of scheduled benefits to grow faster than the economy. As the baby-boom generation reaches retirement age, and as decreasing mortality leads to longer lives and longer retirements, a larger share of the population will draw Social Security benefits.5
The number of people age 65 or older will grow by 90 percent by 2035, compared with growth of just 12 percent for those ages 20 to 64, CBO projects. As a result, by 2035, the older population is likely to be more than one-third the size of the younger group, compared with one-fifth today (see Figure 3-3). About 92 million people will be collecting Social Security benefits in 2035, CBO projects, compared with about 52 million today. Furthermore, the average benefit will have grown nearly as fast as per capita GDP. CBO therefore estimates that unless changes are made to Social Security, spending for the program will rise from 4.3 percent of GDP in fiscal year 2008 to 6.0 percent by 2035. Spending for Social Security will dip slightly as members of the large baby-boom generation die, but it will then resume its upward course because of increasing longevity, reaching 6.1 percent of GDP in 2080.6
The Population Age 65 or Older as a Percentage of the Population Ages 20 to 64, 1962 to 2080
Source: Congressional Budget Office.
CBO’s revenue projections differ slightly under the two scenarios discussed in Chapter 1: the extended-base line scenario, which incorporates the assumption of no change in current law, and the alternative fiscal scenario, which incorporates changes in policy that are widely expected to occur and that policymakers have regularly made in the past. Under the latter scenario, none of the currently scheduled changes to tax law (for example, the expiration at the end of 2010 of the tax changes enacted in 2001 and 2003) would take effect, and the alternative minimum tax would be indexed to inflation. As a result, individual income tax rates (and thus revenues to Social Security from income taxes on benefits) are lower under the alternative fiscal scenario—and the projections of Social Security’s finances are somewhat less favorable—than under the extended-baseline scenario. (Projections of Social Security outlays and of the revenues the program is likely to receive from payroll taxes are identical under the two scenarios.)
Revenues dedicated to the Social Security program will continue to exceed the program’s scheduled outlays until fiscal year 2017, CBO estimates. In the long run, the dedicated revenues will be insufficient to pay scheduled benefits under either scenario. (In developing those projections, however, CBO has assumed that all scheduled benefits will be paid.)
A commonly used measure of the sustainability of a program that has a trust fund and a dedicated revenue source is its actuarial balance—that is, the present value of revenues plus the trust fund balance minus the present value of outlays over a specified period. (The present value is a single number that expresses a flow of current and future income or payments in terms of an equivalent lump sum received or paid today.) That difference is shown as a percentage of the present value of taxable payroll over the same period. (To account for the difference between the trust fund’s current balance and the desired balance at the end of the period, the balance at the beginning of the period is added to the projected revenues, and an additional year of costs at the end of the period is added to projected outlays.) CBO estimates that over the 75-year projection period, dedicated revenues will fall short of scheduled benefits by 1.33 percent of taxable payroll under the extended-baseline scenario (see Table 3-1).7 In other words, to bring the program into actuarial balance over the next 75 years, payroll taxes could be immediately increased by 1.33 percent of taxable payroll and kept at that higher rate, or scheduled benefits could be reduced by an equivalent amount. Under the alternative fiscal scenario, in which the assumption about income tax rates is consistent with that of the Social Security trustees, the shortfall would be 1.54 percent of taxable payroll. That estimate is somewhat smaller than the most recent estimate of the long-range actuarial deficit reported by the trustees.8
Summarized Measures for Social Security Under CBO’s Long-Term Budget Scenarios
(Percentage of taxable payroll)
| Projection Period | Income Rate | Cost Rate | Actuarial Balance | |||
| Extended-Baseline Scenario | ||||||
| 25 Years (2009 to 2033) | 15.3 | 14.9 | 0.4 | |||
| 50 Years (2009 to 2058) | 14.5 | 15.4 | -0.9 | |||
| 75 Years (2009 to 2083) | 14.4 | 15.7 | -1.3 | |||
| Alternative Fiscal Scenario | ||||||
| 25 Years (2009 to 2033) | 15.2 | 14.9 | 0.3 | |||
| 50 Years (2009 to 2058) | 14.4 | 15.4 | -1.0 | |||
| 75 Years (2009 to 2083) | 14.1 | 15.7 | -1.5 | |||
Source: Congressional Budget Office.
Notes: The income and cost rates are the present values of annual revenues and costs over the relevant time period divided by the present value of taxable payroll over that period (after adjustments for the initial trust fund balance and target balance at the end of the relevant time period). The actuarial balance is the present value of revenues minus the present value of costs divided by the present value of taxable payroll over that period.
The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
Slowing the Growth of Social Security Spending
Three broad approaches for constraining the rise in Social Security benefits have received considerable attention. Under those approaches, policymakers could:
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Reduce the size of the initial payments that new Social Security beneficiaries are scheduled to receive, |
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Increase further the age at which workers become eligible for full retirement benefits (which would reduce the initial benefit received at any given age of claiming), or |
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Reduce the annual cost-of-living adjustment that beneficiaries receive once they become eligible for benefits. |
Several CBO papers have analyzed those and other approaches for restructuring the Social Security program.9 In addition to reducing future Social Security benefits, policymakers could restore long-term actuarial balance to the program by raising Social Security taxes or dedicating more general revenue to it.
If policymakers decide to slow the growth of Social Security benefits, considerations of both fairness and economic efficiency point toward enacting new legislation long before the changes take effect. People generally consider the size of their expected Social Security benefits when deciding how much to save and how long to work. Because those benefits are a major source of income for many people, it will be important to enact any benefit reductions well in advance to give people enough time to respond by adjusting their plans for saving and retirement.
Most workers need to earn 40 credits (or quarters) to be eligible for retirement benefits. They can earn up to four credits a year on the basis of the amount they earned in employment covered by Social Security. In 2009, one credit is earned for each $1,090 in wages. Thus, workers earning at least $4,360 this year will receive four credits.
For a more detailed description of that formula and of the rules for determining eligibility and amounts for other types of Social Security benefits, see Congressional Budget Office, Social Security: A Primer (September 2001), Chapter 2.
CBO projects that there will be no cost-of-living adjustments from 2010 through 2012; see Congressional Budget Office, A Preliminary Analysis of the President’s Budget and an Update of CBO’s Budget and Economic Outlook (March 2009), p. 8.
CBO projects that continuing rapid growth in health care costs will reduce the portion of compensation that workers receive in wages subject to the Social Security payroll tax. That development will reduce growth in Social Security benefits as a percentage of GDP and growth in receipts from Social Security taxes below what such growth would otherwise have been.
Expectations for the baby boomers’ retirement are summarized in Congressional Budget Office, The Retirement Prospects of the Baby Boomers, Issue Brief (March 18, 2004); for details, see Congressional Budget Office, Baby Boomers’ Retirement Prospects: An Overview (November 2003).
For details on CBO’s methodology for projecting Social Security’s revenues and outlays, see Updated Long-Term Projections for Social Security (August 2008). For a more general discussion of how the Social Security program works and how changes to it might affect the nation’s ability to deal with impending demographic shifts, see Congressional Budget Office, Social Security: A Primer.
Another commonly used metric is the trust funds’ exhaustion date, which CBO projects will be 2047 under the extended-baseline scenario and 2045 under the alternative fiscal scenario. Once the trust funds are depleted, the Social Security Administration no longer has legal authority to pay benefits. In the years following the trust funds’ exhaustion, annual outlays would be limited to annual revenues, so the benefits that could be paid would be substantially lower than the benefits that were scheduled to be paid. In its August 2008 report titled Updated Long-Term Projections for Social Security, CBO projected benefits under two scenarios: a “payable benefits” scenario, in which outlays are limited by the availability of trust fund balances, and a “scheduled benefits” scenario, in which they are not limited. This report uses the latter scenario.
In their 2009 annual report, the trustees estimated that, on the basis of their intermediate assumptions, the program’s actuarial balance was -2.00 percent of taxable payroll for the 2009–2083 period. See Social Security Administration, The 2009 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds (May 12, 2009), pp. 57–61.
See, for example, Congressional Budget Office, Budget Options, Volume 2 (August 2009). For projections of the financial and distributional effects of numerous specific options, see Congressional Budget Office, Menu of Social Security Options (May 25, 2005). CBO’s analyses of the Social Security program and of several proposals to slow the growth of Social Security spending can be found on the agency’s Web site, in the special collection on Social Security (www.cbo.gov/publications).
