October 2017 Changes to CBO’s Long-Term Social Security Projections Since 2016 Projections of Social Security’s long-term financial out- Since last year, CBO has made changes to its projections look depend critically on estimates of key demographic of five key inputs: productivity in the economy, interest and economic variables. Each year, the Congressional rates, the population, the labor force participation rate, Budget Office updates its projections of the Social and the share of earnings that is subject to Social Security Security system’s finances to incorporate newly available payroll taxes.3 The changes to the first three of those data and information from the research community. inputs worsen the Social Security system’s projected The agency also updates its models to incorporate finances, whereas the changes to the last two improve improvements in methods and feedback on its analytical them. Moreover, an additional year of deficit—2091—is approach. now included in the calculation of the actuarial balance, which worsens the 75-year outlook. Compared with the long-term budget projections CBO made last year, the agency’s latest projections, published CBO projects larger deficits in Social Security’s finances in March, indicate a slight improvement in the financial than do the Social Security Trustees. That difference is outlook for the Social Security system.1 The projected largely explained by CBO’s and the trustees’ different 75-year actuarial balance, a commonly used measure projections of several major inputs into estimates of the of the system’s financial condition, has improved from system’s finances: earnings subject to the Social Security −1.6 percent of gross domestic product (GDP) to payroll tax, components of GDP growth, the population, −1.5 percent of GDP (see Table 1).2 As a percentage of and real interest rates (that is, interest rates adjusted to taxable payroll, the projected 75-year actuarial balance remove the effects of inflation). has improved from −4.7 percent to −4.5 percent. What Is the Effect of Changes in 1. For the 2016 projections and additional information, see Projected Productivity? Congressional Budget Office, The 2016 Long-Term Budget CBO’s estimate of total factor productivity (TFP) Outlook (July 2016), www.cbo.gov/publication/51580, and Congressional Budget Office, CBO’s 2016 Long-Term Projections growth is lower in this year’s long-term projections than for Social Security: Additional Information (December 2016), last year’s, which worsens the projected actuarial bal- www.cbo.gov/publication/52298. For the current projections ance. TFP growth is one component of real growth in and additional information, see Congressional Budget the nation’s economic output—the residual growth that Office, The 2017 Long-Term Budget Outlook (March 2017), reflects all economic development that is not attributable www.cbo.gov/publication/52480, and “CBO’s 2017 Long- to the growth of capital services or labor. That develop- Term Projections for Social Security: Additional Information” (October 2017), www.cbo.gov/publication/53245. ment can include technological progress, changes in the rate at which capital is utilized (which are not captured 2. The actuarial balance is the sum of the present value of projected in CBO’s measure of capital input), changes in the tax revenues and the current trust fund balance minus the sum of the present value of projected outlays and a year’s worth of quality of labor (for example, the overall level of workers’ benefits at the end of a given period, divided by the present educational attainment and experience), institutional value of GDP or taxable payroll. The present value of a flow of change, spillovers from investments in capital, and revenues or outlays over time is a single number that expresses that flow in terms of an equivalent sum received or paid at a specific time. The present value depends on a rate of interest, 3. For more details about changes to CBO’s long-term projections, known as the discount rate, that is used to translate past and see Congressional Budget Office, The 2017 Long-Term future cash flows into current dollars. When the discount rate is Budget Outlook (March 2017), Appendix A, www.cbo.gov/ positive, dollars in the future are worth less than dollars today. publication/52480. 2 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 October 2017 Table 1 . business-cycle effects in estimating potential TFP (which Changes to the 75-Year Actuarial Balance is the TFP consistent with the maximum sustainable output of the economy): Compared with last year, the As a Percentage of agency attributes less of the slow growth of TFP since Taxable 2007 to cyclical weakness and more to underlying GDP Payroll trends, resulting in a lower estimate of growth in poten- July 2016 Projection -1.6 -4.7 tial TFP during the 2000s. That lower estimate modestly Estimated Effects of Revisions to Factors reduces the projected growth rate of both potential and Worsening the Actuarial Balance actual TFP. Productivity -0.1 -0.4 Interest Rates -0.1 -0.2 In CBO’s calculation, slower projected TFP growth leads Population * -0.1 to taxable wages, and therefore payroll tax revenues, that Valuation Period ____* -0.1 ____ are about 3 percent lower in 2033 than they would have Sum -0.2 -0.8 been using last year’s projection. Slower TFP growth also Estimated Effects of Revisions to Factors implies lower benefits, but that effect would be delayed Improving the Actuarial Balance because benefits are not paid until a worker retires (or Labor Force Participation 0.2 0.6 becomes disabled). For example, it would take until Taxable Share 0.1 ____ 0.3 ____ 2047 for spending on benefits to be 3 percent lower Sum 0.3 0.9 than it would have been using last year’s projected TFP growth. In addition, because earlier years receive greater Overall Improvement * 0.2 weight than later years in the calculation of the system’s March 2017 Projection -1.5 -4.5 actuarial balance, the effect of lower revenues outweighs the delayed effect of lower benefits, leading to an overall Source: Congressional Budget Office. negative effect on the Social Security system’s finances. These projections incorporate the assumption that spending for Social Security continues as scheduled even if the Social Security trust funds In CBO’s calculation, slower TFP growth worsens the are exhausted. projected 75-year actuarial balance by about 0.1 percent The actuarial balance is the sum of the present value of projected of GDP, or by 0.4 percent of taxable payroll. tax revenues and the current trust fund balance minus the sum of the present value of projected outlays and a year’s worth of benefits at the What Is the Effect of Changes in end of a given period, divided by the present value of GDP or taxable payroll. The present value of a flow of revenues or outlays over time is Projected Interest Rates? a single number that expresses that flow in terms of an equivalent sum CBO has lowered its projections of interest rates, received or paid at a specific time. The present value depends on a rate which worsens the projected actuarial balance. In the of interest, known as the discount rate, that is used to translate past and calculation of the actuarial balance, the discount rate, future cash flows into current dollars. which is based on projected interest rates, determines The 75-year projection period for the financial measures reported here how much weight is given to each year’s outcomes in begins in 2017 and ends in 2091. the calculation of the present values of taxes and out- Numbers may not sum to totals because of rounding. lays; lower rates increase the weight of future income GDP = gross domestic product; * = between –0.05 and 0.05 percentage and payments. To calculate the Social Security system’s points. actuarial balance, CBO first uses a discount rate based on the average interest rate on all bonds held by the fluctuations in demand. Because it contributes to overall Social Security trust funds. That rate is lower than the output growth, and therefore to the growth of income rate on new special-issue Treasury bonds because many from labor, the TFP growth rate affects both payroll tax of the outstanding bonds were issued at very low rates.4 revenues and benefits. After the combined trust funds are exhausted, the agency uses a discount rate based on the interest rate on new CBO projects that TFP growth will average 1.2 percent over the next 30 years, down from last year’s projection 4. In the last few years before exhaustion of the trust funds, CBO of 1.3 percent (see Figure 1). That revision largely reflects projects that the average rate on all outstanding bonds moves methodological changes in the way CBO accounts for toward the new issue rate. October 2017 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 3 Figure 1 . Growth in Total Factor Productivity Percent 6 4 2 2016 Projection 2017 Projection 0 -2 -4 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 Source: Congressional Budget Office. Total factor productivity growth is one component of real growth in the nation’s economic output—the residual growth that reflects all economic development that is not attributable to the growth of capital services or labor. special-issue Treasury bonds, which CBO takes to equal will be higher than previously estimated. CBO’s revisions the rate on 10-year Treasury notes. In CBO’s projections, to those factors imply higher prices for Treasury securities Social Security’s cost and income generally exhibit larger and, therefore, lower interest rates for them. Beyond the deficits over the longer term than over the shorter term. next decade, CBO expects the effects of lower tolerance Because a lower projected interest rate puts more weight for risk among investors and slower foreign growth to on those larger deficits, it has the effect of worsening the dissipate, but at a slower pace than previously projected. projected actuarial balance. In addition, in its 2016 long-term projections for Social The interest rate CBO uses for the discount rate to Security, CBO used the interest rate on new special-issue calculate Social Security’s 75-year actuarial balance in bonds, which was projected to match the rate on 10-year its current estimates is lower by about 0.7 percentage Treasury notes, in the calculation of the actuarial bal- points, on average, over the next 30 years than it was in ance. The substitution of the average rate on all bonds last year’s projection but is nearly the same thereafter (see held by the trust funds in the years before the trust Figure 2). CBO’s downward revisions to its projections funds’ exhaustion accounts for about one-third of the of interest rates are rooted in several factors. CBO now change in the projected actuarial balance resulting from projects that TFP will grow more slowly than the agency the change in interest rates. anticipated last year. Slower growth in TFP implies lower returns on capital and, in turn, lower interest rates. In In CBO’s calculation, the lower projected interest rates addition, CBO anticipates that investors’ willingness to worsen the 75-year actuarial balance by about 0.1 per- assume risk over the next decade will be lower (and, con- cent of GDP, or by 0.2 percent of taxable payroll. sequently, that their demand for Treasury securities will be higher) than previously projected. CBO also expects What Is the Effect of Changes in that economic growth in other countries will be slower the Projected Population? and, therefore, that both foreign and domestic demand Since last year, CBO has decreased its projections of both for U.S. Treasury securities (relative to foreign securities) the size of the working-age population and the ratio of 4 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 October 2017 Figure 2 . Interest Rate Used in the Calculation of the Actuarial Balance Percent 12 2017 Projection a 10 8 6 2016 Projection b 4 2 2017 Projection of the Measure Used in 2016 b 0 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 Source: Congressional Budget Office. a. The average rate on all bonds held by the Social Security trust funds until their exhaustion in 2030, then the rate on new special-issue Treasury bonds. b. The interest rate on new special-issue Treasury bonds. working-age people (ages 20 to 64) to people of retire- immigration in recent years. Mortality projections have ment age (age 65 or older), thus worsening the projected changed only modestly, resulting in a slightly smaller actuarial balance. The size and composition of the popu- anticipated number of people of retirement age. Fertility lation determine both the number of working-age people projections are unchanged from a year ago. available to support Social Security beneficiaries and the number of those beneficiaries. The fewer working-age CBO estimates that the change in the projected pop- people there are in the population relative to people of ulation worsens the 75-year actuarial balance by less retirement age, the weaker the Social Security system’s than 0.05 percent of GDP, or by about 0.1 percent of finances will be. taxable payroll. CBO’s current projection for the working-age popula- What Is the Effect of Changes in the tion in 2047 is 3.5 percent smaller than last year’s (see Projected Labor Force Participation Rate? Figure 3). The projected ratio of working-age people CBO’s projection of the labor force participation rate is to people of retirement age has fallen by 1.9 percent. higher than it was last year, which improves the projected Projections of the size and composition of the popu- actuarial balance. A higher labor force participation lation are based on projections of three demographic rate—which represents the share of people over the age factors: fertility rates, mortality rates, and net immigra- of 16 in the civilian noninstitutional population who are tion. CBO’s revisions to its projections of population size employed or actively seeking jobs—implies that more and composition result mainly from lower projections people are working and paying payroll taxes and then, of net immigration in both the short and the long term, eventually, receiving benefits. largely reflecting a decrease in the projected number of unauthorized immigrants. That reduction is primarily CBO’s projection of the labor force participation rate for attributable to the agency’s putting more weight in the 2027 has increased by roughly half a percentage point projections on estimates of low levels of unauthorized since last year; the agency’s projection of the labor force October 2017 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 5 Figure 3 . Population by Age Group Millions of People 2016 Estimate 2017 400 Estimate People of 300 Retirement Age (Age 65 or Older) 200 People of Working Age 100 (Ages 20–64) 0 2016 (Actual) 2047 (Projected) 2090 (Projected) Source: Congressional Budget Office. participation rate for 2046 has increased by roughly retire and become eligible for Social Security benefits. 2½ percentage points (see Figure 4).5 The changes since Thus, a higher labor force participation rate initially will last year result from changes in how CBO estimates increase revenues but later will increase both revenues the effects of several factors—chiefly, education and and spending, with some of that spending occurring the marriage rate—on labor force participation. CBO more than 75 years from now. In the calculation of the now projects that increasing educational attainment will system’s actuarial balance, earlier years receive greater have a larger positive effect on participation and that weight than later years, and only spending and revenues the declining marriage rate will have a smaller negative over the next 75 years are included, so the larger amount effect. (Fewer men are projected to be married, and of projected revenues outweighs the effect of greater unmarried men have lower labor force participation rates spending on future benefits and improves the projected than do married men.) In addition, CBO now factors actuarial balance. race and ethnicity into its analysis, which increases the overall projected participation rate. (That change largely As a result, in CBO’s estimation, higher anticipated labor results from CBO’s expectation that Hispanics, who have force participation rates improve the projected 75-year high rates of participation in the labor force, will make actuarial balance by about 0.2 percent of GDP, or by up an increasing share of the population.) 0.6 percent of taxable payroll. Over the full projection period, a higher labor force What Is the Effect of Changes in the participation rate leads to increased receipts from payroll Projected Share of Earnings That taxes. Over time, however, those additional workers will Is Taxable for Social Security? CBO’s projection of the share of earnings that is sub- 5. For additional information, see Joshua Montes, Xiaotong Niu, ject to the Social Security payroll tax, which is the main and Julie Topoleski, “CBO’s Long-Term Projections of source of funding for the program, has increased since Labor Force Participation,” CBO Blog (January 13, 2017), last year, improving the projected actuarial balance. Each www.cbo.gov/publication/52365. CBO also calculates what the labor force participation rate would be if the current composition person working in a job covered by Social Security pays of the population by age and sex were sustained over time, 6.2 percent of his or her wages up to a cap (the taxable and that age- and sex-adjusted rate is also higher in this year’s maximum, equal to $127,200 in 2017); that amount is projection relative to last year’s. 6 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 October 2017 Figure 4 . Labor Force Participation Rates Percent 80 Men 75 70 2016 Projections Overall 2017 Projections 65 60 Women 55 50 45 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 Source: Congressional Budget Office. matched by the worker’s employer (self-employed people projection, the percentage of taxable wages is expected pay the combined 12.4 percent). If a larger share of to fall to about 79 percent. Since last year, CBO has earnings is taxable, revenues will increase, but spending reexamined the historical trends in the growth in earn- will also increase eventually because future beneficiaries ings inequality. In particular, data for the past few years will receive greater benefits. Because earlier years receive show smaller-than-expected increases in the share of greater weight than later years in the calculation of the wages and salaries received by higher earners. Although system’s actuarial balance, and only spending and reve- CBO still expects that the unequal growth in earnings nues over the next 75 years are included, the increased will continue for the next decade before stopping, the revenues outweigh the greater benefits paid in the future, agency now projects a smaller increase in that share over and the actuarial balance improves. that period. Both this year and last year, CBO projected a decline In CBO’s calculation, the change in the projected share over the next decade in the share of earnings that is tax- of earnings that is taxable for Social Security improves able for Social Security, but the anticipated rate of that the projected 75-year actuarial balance by about 0.1 per- decline has slowed (see Figure 5). Because on average, cent of GDP, or by 0.3 percent of taxable payroll. earnings have grown faster for people earning more than the taxable maximum than for those earning less, What Is the Effect of the Change the portion of covered earnings that is taxable has fallen in the Valuation Period? from 90 percent in 1983 to about 82 percent today, and The change in the valuation period for the 75-year CBO projects that it will continue to decline.6 Last year, actuarial balance, which ended in 2090 in last year’s CBO projected that the taxable share would decline to projections and ends in 2091 in this year’s projections, about 77 percent in the long run; in the agency’s current worsens the projected actuarial balance because the cal- culation includes an additional year of deficit (2091).7 In 6. Covered earnings are those received by workers in jobs subject to Social Security payroll taxes. Most workers pay payroll taxes 7. The calculation of the actuarial balance includes the current value on their earnings, although a small number—mostly in state and of the trust funds. In the current projections, that value includes local government jobs or in the clergy—are exempt. the deficit the system ran in 2016. October 2017 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 7 Figure 5 . The Share of Earnings That Is Taxable for Social Security Percent 95 90 85 2017 Projection 80 2016 Projection 75 70 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 Source: Congressional Budget Office. CBO’s estimation, the addition of that year worsens the and higher inflation—all of which increase projected projected actuarial balance by less than 0.05 percent of GDP growth; GDP, or by 0.1 percent of taxable payroll. ■■ The trustees’ projections of population, including How Do CBO’s Projections Compare With higher fertility rates and slower declines in mortality Those of the Social Security Trustees? rates; and The Social Security Trustees’ projection of the 75-year actuarial balance is −1.0 percent of GDP, representing a ■■ The trustees’ projection of higher real interest rates.8 deficit that is 0.5 percentage points smaller than CBO projects. As a percentage of taxable payroll, the trustees’ The projections of Social Security’s long-term finances projection of the 75-year actuarial balance is −2.8 per- made by CBO and the Social Security Trustees are closer cent, representing a deficit that is 1.7 percentage points now than they were in 2016. Relative to last year, the smaller than CBO projects. difference between CBO’s and the trustees’ projections of the 75-year actuarial balance as a share of GDP has The difference between CBO’s projections and those shrunk by 0.1 percentage point, and the difference of the trustees is largely explained by differences in between their projections of the actuarial balance as a projections of four major inputs into estimates of the share of taxable payroll has shrunk by 0.4 percentage system’s finances: points. ■■ The trustees’ higher estimate of earnings subject to the Social Security payroll tax; ■■ The trustees’ different projections of key components 8. For more information on differences between projections, see the testimony of Keith Hall, Director, Congressional Budget Office, of nominal GDP growth—higher labor force before the Subcommittee on Social Security, Committee on Ways participation rates (partially offset by higher and Means, Comparing CBO’s Long-Term Projections With Those of unemployment rates), faster productivity growth, the Social Security Trustees (September 21, 2016), www.cbo.gov/ publication/51988. 8 CHANGES TO CBO’S LONG-TERM SOCIAL SECURITY PROJECTIONS SINCE 2016 October 2017 This Congressional Budget Office report was prepared at the request of the Chairman of the Subcommittee on Social Security of the House Committee on Ways and Means. In keeping with CBO’s mandate to provide objective, impartial analysis, the report makes no recommendations. Michael Simpson prepared the report with guidance from Julie Topoleski and David Weaver. Eva de Francisco, Noah Meyerson, Sam Papenfuss, Charles Pineles-Mark, and Emily Stern provided useful comments on various drafts of the report. Justin Lee fact- checked it. Wendy Edelberg and Jeffrey Kling reviewed the report. Christine Browne edited it, and Casey Labrack prepared it for publication. An electronic version is available on CBO’s website (www.cbo.gov/publication/53209). Keith Hall Director