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Trustees Report- 1996



The long-range financial estimates provided in this section generally relate to the OASI and DI Trust Funds on a combined basis. However, as the OASI and DI programs are legally separate, a final assessment of the financial status of these funds must be provided on a separate basis, as is done later in this section. More detailed estimates for these trust funds, both separately and combined, can be found in section II.F2 of this report.

Each year estimates of the financial and actuarial status of the OASDI program are prepared for the next 75 years. Although financial estimates for periods as long as 75 years are inherently uncertain, the results can provide valuable information for use by policymakers. In particular, such estimates can indicate whether the program - as seen from today's vantage point - is considered to be in satisfactory financial condition.

As mentioned previously, a number of different measures are useful in evaluating the financial status of the trust funds over the next 75 years. In addition to the actuarial balance and the trust fund ratio, emphasis is placed on the relationship between the levels of future tax income and future expenditures for each year (relative to the amount of earnings subject to the OASDI payroll tax). The year-by-year patterns of this relationship are of particular interest.

In addition to the presentation of long-range estimates, a specific test of the program's long-range financial status is applied. This test is referred to as the test for long-range close actuarial balance.

1. Annual Income Rates, Cost Rates, and Balances

Figure I.H1 compares past and estimated future OASDI income (from payroll taxes on covered earnings and income taxes on OASDI benefits) with OASDI expenditures (for benefits and administrative expenses). Included are historical data for the past 11 calendar years (1985-95) and estimates for the 75-year long-range projection period (1996-2070) under the three alternative sets of assumptions. These income and expenditure amounts are shown relative to the earnings in covered employment that are taxable under the OASDI program - referred to as taxable payroll. The ratio of tax income (including both payroll taxes and income from taxation of benefits) to taxable payroll is called the income rate and the ratio of expenditures to taxable payroll is the cost rate.

For calendar year 1996, the income rate for the OASDI program is estimated to be about 12.63 percent of taxable payroll. This rate is made up of the combined tax rate payable by employees and employers, 12.40 percent, plus the revenue from the income taxation of OASDI benefits, equivalent to 0.23 percent of taxable payroll. Since OASDI payroll tax rates are not scheduled to change in the future under present law, payroll tax income as a percentage of taxable payroll remains constant at about 12.40 percent. Income from the taxation of benefits will gradually increase, primarily because a greater proportion of beneficiaries will become subject to taxation. Thus, the income rate is projected to increase somewhat from its current level, reaching about 13.32 percent of taxable payroll by the year 2070. The income rate projection shown in figure I.H1 is based on the intermediate set of assumptions (alternative II) only; the projections under the low cost and high cost sets of assumptions (alternatives I and III, respectively) are very similar.

As figure I.H1 indicates, the pattern followed by the estimated cost rates is much different. Costs as a percentage of taxable payroll are estimated to rise slowly for about 15 years (or to decline slowly, in the case of alternative I) and then to increase rapidly for about the next 20 years. Thereafter, cost rates are estimated to grow less rapidly (or to decline somewhat, in the case of alternative I). By the year 2070 the cost rate is estimated to have reached 13.12 percent, 18.83 percent, and 28.02 percent under alternatives I, II, and III, respectively.

The primary reason that the estimated OASDI cost rate increases rapidly after about 2010 is that the number of beneficiaries is projected to increase more rapidly than the number of covered workers. Because the cost rate expresses expenditures (primarily payments to beneficiaries) as a percentage of taxable payroll (the taxable earnings of covered workers), there is a close relationship between the demographic characteristics of the population and the OASDI cost rate.

Figure I.H2 shows the estimated number of covered workers per OASDI beneficiary. In 1995, there were about 3.3 workers for every beneficiary. As indicated, this ratio is expected to decline substantially in the future under all three sets of assumptions. The most rapid decline will occur as the relatively large number of persons born during the baby boom (from the end of World War II through the mid-1960s) reaches retirement age and begins to receive benefits. At the same time, the relatively small number of persons born during the subsequent period of low fertility rates will comprise the labor force. Between 2030 and 2050, the number of workers per beneficiary is relatively stable as the baby boom generation diminishes in size. After the year 2050, this ratio will continue to decline at a slower pace for the intermediate and high cost projections, reflecting the increasing numbers of beneficiaries due to assumed increases in life expectancy. Based on the low cost assumptions, a slow increase in this ratio is projected to occur after 2050. By the end of the 75-year projection period, the number of workers per beneficiary is projected to decline to 2.4, 1.8, and 1.3 under the low cost (alternative I), intermediate (alternative II), and high cost (alternative III) assumptions, respectively.

The difference between the income rate and the cost rate in a given year is referred to as the annual balance for that year. The estimated pattern of the OASDI annual balance depends significantly on the economic and demographic conditions assumed to occur in the future. Income rates are estimated to exceed cost rates until 2021, 2012, and 2000, under alternatives I, II, and III, respectively, resulting in positive annual balances. Thereafter, under the intermediate assumptions, the annual deficit would rise rapidly, reaching 2 percent of taxable payroll by 2020 and 5.51 percent in the year 2070. Under alternative I, a temporary period of deficits in excess of 1 percent of taxable payroll (from 2027 through 2036) would be followed by a return to relatively small deficits lasting throughout the remainder of the projection period. Under adverse conditions, as assumed in alternative III, the deficit would grow very rapidly, to over 14 percent of taxable payroll by the year 2070.

2. Summarized Income Rates, Cost Rates, and Balances

It is useful to consider the income and cost rates on a summarized basis over the three 25-year subperiods that make up the 75-year projection period. For this purpose, the annual income rates are summarized by calculating the present value of future tax income for the subperiod in question, and expressing it as a percentage of the present value of future taxable payroll for that subperiod. ("Present values" are used in financial analysis to calculate the lump-sum equivalent value, at a particular point in time, of a series of future amounts or transactions. See the Glossary for additional information.) Similarly, a summarized cost rate is calculated, based on the present value of future expenditures as a percentage of the present value of future taxable payroll. Table I.H1 shows these summarized amounts for the OASDI program for the three 25-year subperiods.

A surplus is shown under the intermediate alternative II assumptions for the first subperiod only; thereafter, the program is projected to experience substantial deficits, for the reasons outlined previously. Under the low cost alternative I assumptions, summarized tax income would exceed summarized costs for the first 25-year subperiod only, with deficits diminishing to relatively low levels in the third subperiod. (The less favorable outlook for the second subperiod occurs under the low cost assumptions because the baby-boom generation is retired essentially throughout this period, while the assumed higher ultimate fertility rates have not yet had their full effect on the estimated numbers of workers.) If the high cost conditions of alternative III are experienced, substantial deficits would occur for all three subperiods.

To assess the overall financial balance for the long range, it is customary to calculate summarized income rates and cost rates for the full 75-year period. For this purpose, summarized income and cost rates are calculated on a present-value basis, as before. In addition, the summarized income rate is augmented by the value of trust fund assets on hand at the beginning of the period. Similarly, the summarized cost rate is adjusted to include the additional cost of accumulating trust fund assets at the end of the period equal to 100 percent of the following year's expenditures. The results of this calculation are shown in table I.H2.

The difference between the summarized income and cost rates is called the section II.F2g for complete details on the change in actuarial balance from last year's report.

The size of the actuarial balance for any period represents a measure of the program's financial adequacy for that period. The actuarial balance can be interpreted as the amount of change which, if made to the payroll tax rates scheduled under present law for each year in the period, would bring the program into exact actuarial balance. For example, if the 75-year actuarial deficit of 2.19 percent under intermediate assumptions were addressed by raising scheduled tax rates by 1.10 percent for employees and employers, each, and by 2.20 percent for the self-employed, then OASDI assets at the beginning of 1996, together with income from payroll taxes, interest, and other sources, would be just sufficient to meet all expenditures for the period and leave a trust fund level at the end of the period equal to about 100 percent of the following year's expenditures. Of course, there are numerous other changes to tax rates or benefit provisions that could also result in the elimination of the long-range actuarial deficit.

The 75-year actuarial balance is a convenient and widely used measure of the OASDI program's overall financial status. It is important to remember, however, that this summary measure reflects the combined effects of several very different periods, as previously described. Thus, while the use of summary measures such as the actuarial balance is often convenient, such measures should not be used as a substitute for a more complete understanding of the underlying year-by-year outlook.

3. Trust Fund Ratios

As noted previously, the total income of the OASDI program currently exceeds total expenditures by a substantial margin. As a result, the assets of the combined trust funds are increasing rapidly. Under the intermediate alternative II assumptions, tax income is expected to exceed expenditures until 2012, when the cost of the program will have started to increase with the retirement of the baby-boom generation. From that point on the tax rates scheduled in present law are expected to be insufficient to cover program expenditures and it will be necessary to use interest earned by the combined OASI and DI Trust Funds to make up the shortfall. Total income, including interest earnings, is expected to exceed expenditures through about 2018. Thereafter, it will be necessary to redeem assets to make up the shortfall. If no corrective action were taken, trust fund assets would be exhausted by the end of 2029, after which full benefits would not be payable on a timely basis. The resulting pattern of combined OASI and DI assets, expressed as a percentage of annual expenditures, is illustrated in figure I.H3 under each of the three alternative sets of assumptions.

At the beginning of 1996, the combined assets of the OASI and DI Trust Funds represented about 140 percent of combined annual expenditures estimated for the year. Under alternatives I and II, this ratio would increase at least until 2012. Based on the intermediate assumptions, assets would accumulate to a peak of 245 percent of expenditures in 2011, and would then decline steadily until exhaustion in the year 2029. Based on the intermediate estimates in last year's report, the peak fund ratio for the combined funds was estimated to be 269 percent and the year of exhaustion was estimated to be 2030.

For OASI and DI, separately, the peak fund ratios based on the intermediate assumptions are 284 and 136 percent, respectively, in this year's report and 311 percent and 142 percent, respectively, in last year's report. The reduction in the maximum fund ratio for OASI, DI, and the combined program results primarily from lower expected payroll revenue, based on revised historical wage data (see section II.F2g for details). Table I.H3 summarizes the projections in this year's report for OASI, DI, and the combined trust funds under the three sets of assumptions for the period 1996 through 2070.

Under the low cost alternative I assumptions, the combined trust fund ratio roughly levels off during the retirement years of the baby-boom generation, but resumes increasing by 2040, even though annual balances are negative. This occurs because the assumed trust fund interest rates are high enough to offset the small annual deficits and still keep the trust funds growing faster than annual outgo. For the high cost alternative III, the combined trust fund is permanently exhausted in 2016.

Trust fund assets are generally invested in special Treasury securities so that the excess of cash receipts over expenditures are borrowed from the trust funds by the general fund of the Treasury and used to help meet various Federal outlays. These securities are backed by the full faith and credit of the U.S. Government, the same as other public-debt obligations of the U.S. Government. The assets of the trust funds can be redeemed for cash at any time if required to meet program expenditures. The redemption of a Treasury security held by a trust fund requires that the Treasury transfer cash - obtained from another revenue source, such as income taxes or borrowing from the public - to the trust fund. Thus, the investment operations of the trust funds result in various cash flows between the trust funds and the general fund of the Treasury.

Under the intermediate assumptions, the excess of OASDI income over outgo during the next 16 years will result in a substantial net cash flow from the trust funds of amounts borrowed by the general fund. Thereafter, this cash flow is expected to reverse; as trust fund securities are redeemed to meet benefit payments and other expenditures, revenue from the general fund of the Treasury will be drawn upon to provide the necessary cash. The accumulation and subsequent redemption of substantial trust fund assets has important economic and public policy implications that go well beyond the operation of the OASDI program itself. Discussion of these broader issues is not within the scope of this report.

4. Test of Long-Range Close Actuarial Balance

Because the OASI and DI programs, both separately and combined, have actuarial deficits that are more than 5 percent of the corresponding summarized cost rates over the next 75 years under the Trustees' intermediate (alternative II) assumptions, they do not meet the requirements of the Trustees' formal test for long-range close actuarial balance. (This test is described in detail in section II.F entitled "Actuarial Estimates" later in this report.)

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