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October 22, 2010
Long-Term Budget Projections
Although most of CBO's budget projections and cost estimates cover a 10-year window, the agency regularly conducts studies of the nation's long-term budget picture. The Long-Term Budget Outlook is produced annually, and other studies on long-term issues in Social Security, federal health care programs, and other parts of the budget are produced periodically.
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CBO's 2010 Long-Term Projections for Social Security: Additional Information
Highlights
Social Security is the federal government's largest single program. About 54 million people currently receive Social Security benefits. About 69 percent are retired workers, their spouses, and children and another 12 percent are survivors of deceased workers; all of those beneficiaries receive payments through Old-Age and Survivors Insurance (OASI). The other 19 percent are disabled workers or their spouses and children; they receive Disability Insurance (DI) benefits. Social Security's outlays in fiscal year 2010 totaled $706 billion, one-fifth of the federal budget; OASI payments accounted for 82 percent of those outlays and DI payments made up about 18 percent.
Social Security has two primary sources of tax revenues: payroll taxes and income taxes on benefits. In fiscal year 2010, roughly 97 percent of tax revenues dedicated to Social Security were collected from a payroll tax of 12.4 percent that is levied on earnings and split evenly by workers and their employers at 6.2 percent apiece. Self-employed workers pay the entire 12.4 percent tax on earnings themselves. The payroll tax applies only to taxable earnings—earnings up to a maximum annual amount ($106,800 in 2010). Some Social Security benefits also are subject to taxation: In fiscal year 2010, about 3 percent of Social Security's tax revenues came from the income taxes that higher-income beneficiaries paid on their Social Security benefits. Tax revenues credited to the program totaled $670 billion in that year.
Revenues from taxes, along with intragovernmental interest payments, are credited to Social Security's two trust funds—one for OASI and one for DI—and the program's benefits and administrative costs are paid from those funds. Legally, the funds are separate, but they often are described collectively as the OASDI trust funds. In a given year, the sum of receipts to a fund along with the interest that is credited on previous balances, less spending for benefits and administrative costs, constitutes that fund's surplus or deficit.
In calendar year 2010, Social Security's outlays will exceed tax revenues (that is, the trust funds' receipts excluding interest) for the first time since the enactment of the Social Security Amendments of 1983. Over the next few years, the Congressional Budget Office (CBO) projects, the program's tax revenues will be approximately equal to its outlays. However, as more of the baby-boom generation (that is, people born between 1946 and 1964) enters retirement, outlays will increase relative to the size of the economy, whereas tax revenues will remain at an almost constant share of the economy. Starting in 2016, CBO projects, outlays as scheduled under current law will regularly exceed tax revenues.
CBO projects that the DI trust fund will be exhausted in fiscal year 2018 and that the OASI trust fund will be exhausted in 2042. Once a trust fund's balance has fallen to zero and current revenues are insufficient to cover the benefits that are specified in law, a program will be unable to pay full benefits without changes in law. The DI trust fund came close to exhaustion in 1994, but that outcome was prevented by legislation that redirected revenue from the OASI trust fund to the DI trust fund. In part because of that experience, it is a common analytical convention to consider the DI and OASI trust funds as combined. CBO projects that, if legislation to shift resources from the OASI trust fund to the DI trust fund was enacted, the combined OASDI trust funds would be exhausted in 2039.
The amount of Social Security taxes paid by various groups of people differs, as do the benefits that different groups receive. For example, people with higher earnings pay more in Social Security payroll taxes than do lower-earning participants, and they also receive larger benefits (although not proportionately larger). Because of the progressive nature of Social Security's benefit formula, replacement rates—the amount of annual benefits as a percentage of annual lifetime earnings—are lower, on average, for workers who have had higher earnings. As another example, the amount of taxes paid and benefits received will be greater for people in later birth cohorts because they typically will have higher earnings over a lifetime, even after adjusting for inflation, CBO projects. However, replacement rates will be slightly lower, on average, for people in later birth groups because their full retirement age (the age at which they can receive unreduced retirement benefits) will be higher.
About This Analysis
CBO regularly prepares long-term projections of revenues and outlays for the Social Security program. The most recent projections, for the 75 years from 2010 through 2084, were published in Chapter 3 of The Long-Term Budget Outlook (June 2010, revised August 2010). This publication presents additional information about those projections.
The budget projections published in The Long-Term Budget Outlook involved two scenarios: The first, CBO's extended-baseline scenario, adheres closely to current law. For example, that scenario reflects the assumption that the tax cuts enacted in 2001 and 2003 expire as scheduled at the end of 2010. CBO also has developed an alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. Unless otherwise noted, the projections presented in this analysis are based on the assumptions of the extended-baseline scenario. In that scenario, income taxes, including the income taxes on Social Security benefits that are credited to the trust funds, are higher than they are in the alternative fiscal scenario.
Scheduled and Payable Benefits
CBO prepared two types of benefit projections. Benefits as calculated under the Social Security Act, regardless of the balances in the trust funds, are called scheduled benefits. The Social Security Administration has no legal authority to pay scheduled benefits if their amounts exceed the balances in the trust funds, however. Therefore, if the trust funds became exhausted, payments to current and new beneficiaries would need to be reduced to make the outlays from the funds equal the revenues flowing into the funds. Benefits thus reduced are called payable benefits. In such a case, all receipts to the trust funds would be used and the trust fund balances would remain essentially at zero. When presenting projections of Social Security's finances, CBO generally focuses on scheduled benefits because, by definition, the system would be fully financed if only payable benefits are disbursed.
Quantifying Uncertainty
To quantify the amount of uncertainty in its Social Security projections, CBO created a distribution of outcomes from 500 simulations using its long-term model. In those simulations, the assumed values for most of the key demographic and economic factors that underlie the analysis—for example, fertility and mortality rates, interest rates, and the rate of growth of productivity—were varied on the basis of historical patterns of variation. Several of the exhibits in this publication show the simulations' 80 percent range of uncertainty: That is, in 80 percent of the 500 simulations, the value in question fell within the range shown; in 10 percent of the simulations, the values were above that range; and in 10 percent they were below. Long-term projections are necessarily uncertain, and that uncertainty is illustrated in this publication; nevertheless, the general conclusions of this analysis hold true under a variety of assumptions.
System Finances
The first part of this publication (Exhibits 1 through 8) examines Social Security's financial status from several vantage points. The fullest perspective is provided by projected streams of annual revenues and outlays. A more succinct analysis is given by measures that summarize the annual streams in a single number. The system's finances are also described by projecting what is called the trust fund ratio, the amount in the trust funds at the beginning of a year in proportion to the outlays in that year.
The Distribution of Benefits
In the second part (Exhibits 9 through 16), CBO examines the program's effects on people by grouping Social Security participants by various characteristics and presenting the average taxes and benefits for those groups. In its analysis, CBO divided people into groups by the decade in which they were born and by the quintile of their lifetime household earnings. For example, one 10-year cohort consists of people born in the 1940s, and the top fifth of earners constitutes the highest earnings quintile. CBO's modeling approach produces estimates for individuals; household status is used only to place people into earnings groups.
In this part of the analysis, benefits are calculated net of income taxes paid on benefits by higher-income recipients and credited to the Social Security trust funds. Median values are estimated for each group: Estimates for half of the people in the group are lower and estimates for half are higher.
Most retired and disabled workers receive Social Security benefits on the basis of their own work history. This publication first presents measures of those benefits that do not include benefits received by dependents or survivors who are entitled on the basis of another person's work history. Then, for a more comprehensive perspective on the distribution of Social Security benefits, this analysis presents measures of the total amount of Social Security payroll taxes that each participant pays over his or her lifetime as well as the total Social Security benefits—including payments received as a worker's dependent or survivors—that each receives over a lifetime.
Changes in CBO's Long-Term Social Security Projections Since 2009
The shortfalls for Social Security that CBO is currently projecting are larger than the shortfalls projected in CBO's Long-Term Projections for Social Security: 2009 Update (August 2009). The 75-year imbalance has increased from 1.3 percent to 1.6 percent of taxable payroll under the extended-baseline scenario and from 1.5 percent to 2.1 percent of taxable payroll under the alternative fiscal scenario. Those differences are attributable to changes both in projected outlays and in projected revenues. The 75-year cost rate—a measure of outlays—is about 2 percent higher under both scenarios because of near-term economic weakness, slightly lower projections of real (inflation-adjusted) growth in wages, and technical changes in modeling methods. The projected 75-year income rate—a measure of Social Security's revenues—is slightly higher than CBO estimated in 2009 under the extended-baseline scenario because income taxes on benefits are projected to be higher as a share of benefits. However, the income rate is about 1 percent lower than in 2009 under the alternative fiscal scenario because income taxes on benefits are projected to equal a smaller share of benefits.
Related CBO Analyses
Further information about Social Security and CBO's projections is available in other CBO publications:
- Various approaches to changing the program are presented in Social Security Policy Options (July 2010).
- The current long-term projections are consistent with the 10-year baseline CBO published in A Preliminary Analysis of the President's Budgetary Proposals for Fiscal Year 2011 (March 2010). (Data in that report and in The Long-Term Budget Outlook are generally presented for fiscal years; this analysis and Social Security Policy Options use calendar-year data.)
- The current projections update those in CBO's Long-Term Projections for Social Security: 2009 Update. Differences in the two sets of projections are the result of newly available programmatic and economic data, updated assumptions about future economic trends, and improvements in models. This current set of projections also incorporates the effects of the health care legislation passed in March 2010.
- The methodology used to develop the projections in this publication is described in CBO's Long-Term Model: An Overview, a background paper published in June 2009.
- Appendix B of The Long-Term Budget Outlook offers an explanation of the values used for the demographic and economic variables underlying the projections. (As was the case for CBO's 2009 projections, the projections in this publication are based on the demographic assumptions of the 2009 report of the Social Security trustees.)
- Numerous other aspects of the program are addressed in various publications available from CBO's Web site.
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Full Text
- Director's Slideshow
- document
Supplemental Material
- Blog Post
The Economic Outlook and Fiscal Policy Choices
Highlights
This testimony reviews the Congressional Budget Office's (CBO's) recent analyses of the economic outlook and the potential impact on the economy of various fiscal policy options. It also adds to those analyses by quantifying the economic impact of extending some or all of the 2001 and 2003 tax cuts that are scheduled to expire in three months.
The Economic Outlook
CBO expectsas do most private forecastersthat the economic recovery will proceed at a modest pace during the next few years. In its projections released in August, CBO forecast that, under current laws governing federal spending and revenues, real (inflation-adjusted) gross domestic product (GDP) would increase by 2.8 percent between the fourth quarter of 2009 and the fourth quarter of 2010 and by 2.0 percent between the fourth quarters of 2010 and 2011. With economic growth so slow, the unemployment rate would remain above 8 percent until 2012 and above 6 percent until 2014. Since CBO completed that forecast, the economic data released have been weaker than the agency had expected, so if CBO was redoing the forecast today, it would project slightly slower growth in the near term.
Slides from the Director's Testimony
The Economic Outlook and Fiscal Policy Choices
View more presentations from Congressional Budget Office.
The pace of recovery since the recession ended in June 2009 and the growth that CBO projects for the next few years are anemic relative to the rate of recovery following previous deep recessions. However, the most recent recession, spurred by a financial crisis, was unlike any this country has seen for a very long time, and there is reason to expect that the country's recovery will also be different from past ones: International experience suggests that recoveries from recessions that begin with financial crises tend to be slower than average. Following such a crisis, it takes time for equity and asset markets to recover, for households to replenish their resources and boost their spending, for financial institutions to restore their capital bases, and for businesses to regain the confidence required to invest in new plant and equipment. In addition, the scheduled increases in taxes and the waning of fiscal policy measures that supported the economy earlier in this recovery will hold down spending, especially in 2011. The weak demand for goods and services resulting from those various factors is the primary constraint on economic recovery.
A weak economy has serious social consequences. In addition to the millions of Americans who are officially unemployed, many others are underemployed or have left the labor force. Moreover, the unemployment rate has risen disproportionately for men, for less-educated workers, and for people living in certain states, and long-term -unemployment has increased strikinglyto the point that the incidence of unemployment lasting longer than 26 weeks is now the highest by far in the past 60 years. Of course, losing a job often has a significant impact on workers and their families, both in the short term and in the long term.
Fiscal Policy Approaches and Long-Term Budgetary Constraints
Policymakers cannot reverse all of the effects of the housing and credit boom, the subsequent bust and financial crisis, and the deep recession. However, in CBO's judgment, there are both monetary and fiscal policy options that, if applied at a sufficient scale, would increase output and employment during the next few years. Those same fiscal policy options would, though, have longer-term economic costs. In particular, the cuts in taxes or increases in spending that would provide a short-term economic boost would also increase federal debt.
Federal debt held by the public is already larger relative to the size of the economy than it has been in more than 50 years, and it is headed higher. According to CBO's baseline projections, under current law, debt held by the public would be close to 70 percent of GDP for most of the coming decade. But other policies could result in substantially more debt. For example, if the 2001 and 2003 tax cuts were extended, the individual alternative minimum tax (or AMT) was indexed for inflation, and future annual appropriations remained the share of GDP that they are this year, the deficit in 2020 would equal about 8 percent of GDP, and debt held by the public would reach nearly 100 percent of GDP. Such a path for federal debt is clearly unsustainable. Persistent deficits and continually mounting debt would crowd out growing amounts of private investment, require rising interest payments, restrict the ability of policymakers to respond to unexpected challenges, and increase the probability of a sudden fiscal crisis.
Despite that grim picture, there is no intrinsic contradiction between providing additional fiscal stimulus today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential. What does that mean in practice? If taxes were cut permanently, or government spending was increased permanently, and no other changes were made to fiscal policy, the federal budget would be on an unsustainable path, and the economy would suffer. Even if tax cuts or spending increases were temporary, the additional debt accumulated during that temporary period would weigh on the budget and the economy over time. Therefore, if policymakers wanted to achieve both short-term stimulus and long-term sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it relative to current baseline projections after a few years. Developing such a combination would be feasible but not easy.
If policies that widened the deficit in the near term were enacted, observers might question whether, when, and how the difficult actions to narrow the deficit later would be carried out. The most important uncertainty facing families and businesses today is uncertainty about the path of the economy, but uncertainty about government policies is probably also a drag on businesses' hiring and investing and perhaps on consumer spending as well. The enactment of policies that improved the budget outlook beyond the next few years would help to reduce that uncertainty.
CBO's Analysis of Fiscal Policy Options
To assist policymakers in their decisions, CBO has quantified the effects that some alternative fiscal policy options would have on the economy. In a January 2010 report, CBO estimated the effects of a diverse set of temporary policy options. The agency reported the results in terms of the two-year effect on the economy per dollar of total budgetary cost, what one might informally call the bang for the buck. The overall effects of those policies on the economy would depend also on the scale at which they were implemented; making a significant difference in an economy with an annual output of nearly $15 trillion would involve a considerable budgetary cost.
CBO's key conclusions from that analysis are as follows:
- A temporary increase in aid to the unemployed would have a significant positive short-term effect on the economy per dollar of budgetary cost. Such an increase would slightly raise unemployment among the affected individuals, but it would also raise people's spending and thereby increase output and employment in the economy overall.
- A temporary reduction in payroll taxesespecially in the share of taxes paid by employerswould also have a significant positive short-term effect on the economy. This approach would boost output and employment both by increasing demand for goods and services and by providing an incentive for additional hiring.
- A number of other temporary policy options, including the expensing of business investment and providing aid to states, would have smaller positive short-term effects on output and employment.
- A temporary increase in infrastructure investment and a temporary across-the-board reduction in income taxes would have still smaller short-term effects on -output and employment per dollar of budgetary cost.
In its January study, CBO also explained that those policy actions would lead to the accumulation of additional government debt that would reduce income in the longer term unless other policies with offsetting effects on future debt were enacted. However, CBO did not quantify those future reductions in income.
At the request of the Chairman, CBO has now estimated the short-term and the longer-term effects of certain tax policy options being considered by the Congress. In particular, CBO studied the effects of extending the 2001 and 2003 tax cuts; extending the higher exemption amounts for the AMT that were in effect in 2009 (adjusted for inflation) for 2010 and subsequent years; and reinstating the estate tax, which expired completely in 2010, for 2011 and subsequent years at the rates in effect in 2009 and with the exemption amounts (adjusted for inflation) that applied in that year. CBO examined four alternative approaches to making those changes: a permanent change affecting all provisions (labeled a full permanent extension), a permanent change but without extending certain provisions that would apply only to high-income taxpayers (labeled a partial permanent extension), a change affecting all provisions but only through 2012 (full extension through 2012), and a change through 2012 but without extending certain provisions that would apply only to high-income taxpayers (partial extension through 2012).
The methodology for this analysis was quite similar to the methodology that CBO uses in analyzing the President's budget each spring. CBO used several models that make different simplifying assumptions about people's behavior. The models used to estimate the effects on the economy in 2011 and 2012 focus on the policies' impact on the demand for goods and services, because CBO expects that economic growth in the near term will be restrained by a shortfall in demand. All else being equal, lower tax payments increase demand for goods and services and thereby boost economic activity. In contrast, the models used to estimate the effects on the economy in 2020 and later years focus on the policies' impact on the supply of labor and capital, because CBO believes that economic growth over that longer horizon will be restrained by supply factors. All else being equal, lower tax revenues increase budget deficits and thereby government borrowing, which crowds out investment, while lower tax rates increase people's saving and work effort; the net effect on economic activity depends on the balance of those forces. Because the responsiveness of people's work effort to changes in their after-tax compensation is uncertain, CBO produced estimates based on alternative assumptions about such behavioral responses.
Notwithstanding CBO's use of alternative models and assumptions, the actual effects of the policy options studied could fall above or below the estimates that CBO reports. With that caveat, the key findings are these:
- All four of the options for extending the expiring income tax cuts would raise output, income, and employment during the next two years, relative to what would occur under current law. A full permanent extension or partial permanent extension would provide a larger boost to income and employment in the next two years than would a temporary extension, and a full extension would provide a larger boost than would the corresponding partial extension.
- But the effects of those policy options on the economy in the longer term would be very different from their effects during the next two years. For some of the options, the estimates based on different models and assumptions cover a broad range. Still, the estimates indicate that all four of the options would probably reduce income relative to what would otherwise occur in 2020. Beyond 2020, and again relative to what would occur under current law, the reductions in income from all four of the policy options would become larger. Either a full or a partial extension of the tax cuts through 2012 would reduce income by much less than would a full or partial permanent extension.
In sum, and as CBO has reported before, permanently or temporarily extending all or part of the expiring income tax cuts would boost income and employment in the next few years relative to what would occur under current law. However, even a temporary extension would add to federal debt and reduce future income if it was not accompanied by other changes in policy. A permanent extension of all of those tax cuts without future increases in taxes or reductions in federal spending would roughly double the projected budget deficit in 2020; a permanent extension of those cuts except for certain provisions that would apply only to high-income taxpayers would increase the budget deficit by roughly three-quarters to four-fifths as much. As a result, if policymakers then wanted to balance the budget in 2020, the required increases in taxes or reductions in spending would amount to a substantial share of the budgetand without significant changes of that sort, federal debt would be on an unsustainable path that would ultimately reduce income. Similarly, even temporary increases in government spending would add to federal debt and reduce future income, and permanent large increases in spending that were not accompanied by other spending reductions or tax increases would put federal debt on an unsustainable path. Compared with the options examined here for extending the expiring tax cuts, various other options for temporarily reducing taxes or increasing government spending would provide a bigger boost to the economy per dollar of cost to the federal government.
Highlights
CBO has compiled historical statistics on federal debt held by the public reaching back to 1790, measured against the size of the economy that existed at the time. The resulting line graph first appeared in the agencys December 2005 Long-Term Budget Outlook. The data on federal debt come from the Department of the Treasury and the Board of Governors of the Federal Reserve System, and the data on the gross domestic product come from a variety of sources, both private and governmental, as enumerated in the spreadsheet that CBO is providing. Most recently, in the July 2010 issue brief Federal Debt and the Risk of a Fiscal Crisis, the historical data were paired with projections showing two scenarios for the long term, through 2035.
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Original and Revised Projections of Crowding-Out Effects in The Long-Term Budget Outlook, 2010
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Federal Debt and the Risk of a Fiscal Crisis
Highlights
Over the past few years, U.S. government debt held by the public has grown rapidlyto the point that, compared with the total output of the economy, it is now higher than it has ever been except during the period around World War II. The recent increase in debt has been the result of three sets of factors: an imbalance between federal revenues and spending that predates the recession and the recent turmoil in financial markets, sharply lower revenues and elevated spending that derive directly from those economic conditions, and the costs of various federal policies implemented in response to the conditions.
Further increases in federal debt relative to the nations output (gross domestic product, or GDP) almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending, measured as a percentage of GDP, well above the levels experienced in recent decades. Unless policymakers restrain the growth of spending, increase revenues significantly as a share of GDP, or adopt some combination of those two approaches, growing budget deficits will cause debt to rise to unsupportable levels.
Although deficits during or shortly after a recession generally hasten economic recovery, persistent deficits and continually mounting debt would have several negative economic consequences for the United States. Some of those consequences would arise gradually: A growing portion of peoples savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers; that crowding out of investment would lead to lower output and incomes than would otherwise occur. In addition, if the payment of interest on the extra debt was financed by imposing higher marginal tax rates, those rates would discourage work and saving and further reduce output. Rising interest costs might also force reductions in spending on important government programs. Moreover, rising debt would increasingly restrict the ability of policymakers to use fiscal policy to respond to unexpected challenges, such as economic downturns or international crises.
Beyond those gradual consequences, a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the governments ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis. But as other countries experiences show, it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply. The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the governments long-term budget outlook, its near-term borrowing needs, and the health of the economy. When fiscal crises do occur, they often happen during an economic downturn, which amplifies the difficulties of adjusting fiscal policy in response.
If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. To restore investors confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.
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