CHAPTER
3
The Long-Term Outlook for Social Security
Social Security is the federal government’s largest single 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 50 million people now receive Social Security benefits.
During the program’s first four decades, spending for Social Security benefits steadily increased relative to the size of the economy, reaching about 4 percent of gross domestic product in the mid-1970s (see Figure 3-1). That spending was driven largely by repeated expansions of the program. Since then, spending for Social Security benefits has mostly fluctuated between 4.1 percent and 4.5 percent of GDP. In fiscal year 2007, it accounted for 4.3 percent of GDP.
Spending for Social Security as a 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. Workers whose employment has been limited because of a physical or mental disability can become eligible for DI benefits at an earlier age and often 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, they receive payments based on their average earnings over their working lifetime; those payments are subsequently adjusted to reflect annual changes in the cost of living. The formula used to translate average earnings into benefits is progressive: In other words, it replaces a larger share of preretirement earnings for people with lower average earnings than it does for people with higher earnings. Both the earnings history and the specific dollar amounts included in the formula are indexed to changes in average annual earnings for the labor force as a whole.1 Because average national earnings generally grow faster than the rate of inflation, that indexation causes initial benefits for future recipients to grow in real (inflation-adjusted) terms.
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 be approximately equally valuable 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 rises by two months per birth year for people born from 1938 through 1943 and again by two months per year for people born from 1955 through 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 2008 having had average earnings throughout their career will be eligible for an annual benefit of about $15,000. That amount will replace nearly 40 percent of their preretirement earnings. In later decades, the replacement rate will be less for workers with average earnings who retire at age 65, mainly because of the scheduled increase in the normal retirement age.
Nevertheless, because initial benefits are indexed to average wages, which grow over time, the real value of those benefits will continue to rise.
Although Social Security is often characterized as a retirement program, it also provides other benefits. Indeed, only about 63 percent of its beneficiaries receive their payments as retired workers (see Figure 3-2). As of September 2007, 14 percent of beneficiaries were disabled workers, 13 percent were survivors of deceased workers, and the remaining 10 percent were spouses or children of retired or disabled workers.
Distribution of Social Security Beneficiaries, by Type of Benefits Received, September 2007
Source: Congressional Budget Office based on Social Security Administration, "Monthly Statistical Snapshot, September 2007," Table 2.
Benefits are funded primarily through payroll taxes imposed on workers and their employers, with a small portion of revenues derived from income taxes on the benefits of higher-income beneficiaries. Only earnings up to a maximum annual amount 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. The revenues 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
The cost of the Social Security program will rise noticeably in coming decades—a change that has long been foreseen.2 Average benefits typically grow when the economy does (because the earnings on which those benefits are based increase). However, in the future, the total amount of scheduled benefits will grow faster than the economy because of changes in the nation’s demographic structure.3 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.
4 Moreover, whereas the number of people ages 20 to 64 is projected to grow by 11 percent in the next 30 years, the number of people age 65 or older is projected to double. As a result, in three decades, 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). By 2030, the Congressional Budget Office anticipates, about 86 million people will be collecting Social Security benefits, compared with about 50 million today. The average benefit will have grown by about 29 percent in real terms. Consequently, CBO estimates that unless changes are made to Social Security, spending for the program will rise from 4.3 percent of GDP in fiscal year 2007 to 6.1 percent of GDP by 2030. With further increases in life spans, spending for Social Security will gradually rise thereafter, reaching 6.4 percent of GDP in 2082.
The Population Age 65 or Older as a Percentage of the Population Ages 20 to 64
Source: Congressional Budget Office.
Revenues dedicated to the Social Security program will continue to exceed the program’s scheduled outlays for another decade, CBO estimates. In the long run, the dedicated revenues will be insufficient to pay scheduled benefits. (For the purposes of these projections, however, CBO has assumed that all scheduled benefits will be paid.) As discussed in the preceding chapter, 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 minus the present value of outlays over a specified period). CBO estimates that over the 75-year projection period, dedicated revenues will fall short of scheduled benefits by about 1.8 percent of taxable payroll (see Table 3-1).5 In other words, to bring the program into actuarial balance over the next 75 years, payroll taxes could be immediately increased by 1.8 percent of taxable payroll and kept at that higher rate, or scheduled benefits could be reduced by an equivalent amount. That estimate is similar to the most recent estimate of the long-range actuarial deficit reported by the Social Security trustees.6
Measures of Projected Income, Costs, and Balances for Social Security
(Percentage of taxable payroll)
|
Projection Period |
Income Rate
|
Cost Rate
|
Actuarial Balance |
|
|
|
|
|
|
|
|
|
|
|
25 Years (2008 to 2032) |
14.9
|
14.1
|
0.8
|
|
50 Years (2008 to 2057) |
14.3
|
15.3
|
-1.0
|
|
75 Years (2008 to 2082) |
14.1
|
15.9
|
-1.8
|
|
|
|
|
|
Source: Congressional Budget Office.
Note: 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 income minus the present value of costs divided by the present value of taxable payroll over that period.
Slowing the Growth of Social Security Spending
Three broad approaches for constraining the rise in Social Security benefits have received considerable attention. First, policymakers could reduce the size of the initial payments that new Social Security beneficiaries are scheduled to receive. Second, they could increase further the age at which workers become eligible for full retirement benefits (which would reduce the benefit received at any given age of initial claiming). Third, policymakers could reduce the annual cost-of-living adjustment that beneficiaries receive once they become eligible for benefits. Several CBO papers have analyzed those approaches as well as various plans for restructuring the Social Security program.7 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 revenues 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 often consider the size of their expected Social Security benefits when they decide how much to save and how long to work. Because Social Security benefits are a major source of income for many people, it would be important to enact any benefit reductions well in advance so people would have enough time to respond by adjusting their plans for saving and retirement.
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.
For details on the Congressional Budget Office’s methodology for projecting Social Security’s revenues and outlays, see Updated Long-Term Projections for Social Security (June 2006). 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.
As discussed in Chapter 5, the Congressional Budget Office 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 (March 18, 2004); for details, see Congressional Budget Office, Baby Boomers’ Retirement Prospects: An Overview (November 2003).
Another commonly used metric is the trust fund exhaustion date. The Social Security Administration has legal authority to pay benefits only from balances in the Social Security trust funds, which CBO projects will be exhausted in 2043. Once that occurred, the Social Security Administration would no longer have the legal authority to pay full benefits. In the years following trust fund exhaustion, payable benefits would be substantially lower than scheduled benefits because annual outlays would be limited to annual revenues. In its report titled Updated Long-Term Projections for Social Security, CBO projected benefits under two scenarios: a "benefits payable" scenario, in which outlays are limited by the availability of trust fund balances, and a "benefits scheduled" scenario, in which they are not limited. This report uses the latter scenario.
In their 2007 annual report, the trustees estimated that, on the basis of their intermediate assumptions, the program’s actuarial balance was -1.95 percent of taxable payroll for the 2007–2081 period (which ends one year earlier than the 2008–2082 period considered here). See Social Security Administration, The 2007 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds (April 23, 2007), pp. 54–58.
See, for example, Congressional Budget Office, Budget Options (February 2007), pp. 211–225. 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 at the agency’s Web site, in the special collection on Social Security, which is available at CBO publications.
