The basic economic assumptions are embodied in three alternatives that are designed to provide a reasonable range of effects on Social Security’s financial status. The intermediate assumptions reflect the Trustees’ consensus expectation of moderate economic growth throughout the projection period. The low cost assumptions represent a more optimistic outlook, with relatively strong economic growth. The high cost assumptions represent a relatively pessimistic scenario, with weak economic growth and two
recessions in the short-range period.
Based on the latest data and estimates, the economy is assumed to have been above its sustainable potential level of output and employment during the latter half of 2007. Under all three sets of assumptions the economy is assumed to reach the sustainable, potential level of output by the end of the short-range period. Economic cycles are not included in the assumptions beyond the first 5 to 10 years of the projection period because they have little effect on the long-range estimates of financial status.
This report also includes a stochastic projection that provides a probability distribution of possible future outcomes that is centered around the Trustees’ intermediate assumptions. Additional economic assumptions and modeling are required for these projections. These are discussed in Appendix
E.
The following sections 1 through
4 present the principal economic assumptions for the three alternatives that are summarized in table
V.B1. The subsequent sections
5 through
7 present additional economic factors, summarized in table
V.B2, that are critical to the projections of the future financial status of the combined OASI and DI Trust Funds.
Total U.S. economy productivity is defined as the ratio of real gross domestic product (GDP) to hours worked by all workers.
1 The rate of change in total- economy productivity is a major determinant in the growth of average earnings. For the 40 years from 1966 to 2006, annual increases in total productivity averaged 1.7 percent, the result of average annual increases of 2.0, 1.3, 1.2, and 2.1 percent for the 10-year periods 1966-76, 1976-86, 1986-96, and 1996‑2006, respectively. However, it should be noted that this growth rate of 1.7 percent reflects a shift of employment from low (farm) to high (nonfarm) productivity sectors that is not expected to continue in the future.
Because productivity growth can vary substantially within economic cycles, it is more useful to consider historical average growth rates for complete economic cycles. The annual increase in total productivity averaged 1.6 percent over the last four complete economic cycles (measured from peak to peak), covering the 34-year period from 1966 to 2000. The annual increase in total productivity averaged 2.2, 1.2, 1.2, and 1.6 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively.
The ultimate annual increases in productivity are assumed to be 2.0, 1.7, and 1.4 percent for the low cost, intermediate, and high cost assumptions, respectively. These rates of increase are the same as those used in the 2007 report, and reflect the belief that recent strong growth in nonfarm business productivity, after the relatively poor performance from 1973 to 1995, is consistent with future long-term growth that mirrors the long-term trends of the past.
For the intermediate assumptions, the annual change in productivity is assumed to be about 1.4 percent for 2007, average about 1.9 percent for 2008 and 2009, then gradually decline to the ultimate assumed level of 1.7 percent by 2014. For the low cost assumptions, the annual change in productivity averages about 2.1 percent over the 2007 to 2012 period, and reaches the ultimate assumed level of 2.0 percent by 2017. For the high cost assumptions, the annual change in productivity decreases from 1.4 percent for 2007 to 0.1 percent for 2008. Thereafter, the annual change in productivity varies with economic cycles until reaching its ultimate growth rate of 1.4 percent for 2017.
Future changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (hereafter denoted as CPI) will directly affect the OASDI program through the
automatic cost-of-living benefit increases. Future changes in the GDP chain-type price index (hereafter, the GDP deflator) affect the nominal levels of GDP, wages, self-employment income, average earnings, and
taxable payroll.
Historically, the CPI increased at an average annual rate of 4.6 percent for the 40 years from 1966 to 2006, the result of average annual increases of 5.8, 6.6, 3.6, and 2.5 percent for the 10-year periods 1966-76, 1976-86, 1986-96, and 1996-2006, respectively. The GDP deflator increased at an average annual rate of 4.1 percent from 1966 to 2006, the result of average annual increases of 5.7, 5.9, 2.8, and 2.2 percent for the same respective 10-year periods.
The ultimate annual increases in the CPI are assumed to be 1.8, 2.8, and 3.8 percent for the low cost, intermediate, and high cost assumptions, respectively. These rates of increase are the same as those used in the 2007 report, and reflect a belief that future inflationary shocks will likely be offset by succeeding periods of relatively slow inflation due to persistent international competition, and that future monetary policy will be similar to the recent past, with its strong emphasis on holding the growth rate in prices to relatively low levels.
For each alternative, the ultimate annual increase in the GDP deflator is assumed to be equal to the annual increases in the CPI minus a 0.4 percentage point price differential. This differential is based primarily on methodological differences in the construction of the two indices, and is the same as the one used in the 2007 report. Hence, for the intermediate assumptions, the ultimate annual increase in the GDP deflator is 2.4 percent, equal to the 2.8 percent assumed ultimate annual increase in the CPI less the 0.4 percentage point price differential. Similarly, the ultimate annual increases in the GDP deflator are 1.4 and 3.4 percent for the low cost and high cost assumptions, respectively.
For the intermediate assumptions, the annual change in the CPI is assumed to decrease from 2.8 percent for 2007 to 2.5 percent for 2009, then rise gradually to the assumed ultimate rate of 2.8 percent for 2010 and later. For the low cost assumptions, the annual change in the CPI is assumed to decrease from 2.8 percent for 2007, to the assumed ultimate rate of 1.8 percent by 2010. For the high cost assumptions, the annual change in the CPI mostly increases from 2.8 percent for 2007 to 5.7 percent by 2012, then decreases to its assumed ultimate rate of 3.8 percent as of 2016. The price differential, defined as the percent change in the CPI less the GDP deflator percent change, is estimated to be 0.1 percentage point for 2007. For 2008, the price differential is assumed to be 0.8 percentage point, reflecting the relative effects on the two price measures of the rise in oil prices in the second half of 2007. For all three alternatives, the price differential is projected to be approximately 0.4 percentage point for 2009 and later.
The level of average (nominal) earnings in OASDI covered employment for each year has a direct effect on the size of the taxable payroll and on the future level of average benefits. In addition, increases in the level of average wages in the U.S. economy directly affect the indexation, under the automatic-adjustment provisions in the law, of the OASDI benefit formulas, the contribution and benefit base, the exempt amounts under the retirement
earnings test, the amount of earnings required for a quarter of coverage, and under certain circumstances, the automatic cost-of-living benefit increases.
Average U.S. earnings is defined as the ratio of the sum of total U.S. wage and salary disbursements and proprietor income to the sum of total U.S. military and total civilian (household) employment. The growth rate in average U.S. earnings for any period is equal to the combined growth rates for total U.S. economy productivity, average hours worked, the ratio of earnings to compensation (which includes fringe benefits), the ratio of compensation to GDP, and the GDP deflator. Assumed future growth rates in productivity and the GDP deflator are discussed in the previous two sections.
The average annual change in average hours worked was ‑0.3 percent over the last 40 years, and -0.9, -0.1, 0.3, and -0.3 percent for the 10-year periods 1966-76, 1976-86, 1986‑96 and 1996‑2006, respectively. The average annual change in average hours worked was -0.2 percent over the last four complete economic cycles covering the period from 1966 to 2000. The annual change in average hours worked averaged -0.7, -0.6, 0.0, and 0.1 percent over the economic cycles 1966-73, 1973-78, 1978-89, 1989-2000, respectively.
For the 2008 report, the ultimate annual rates of change for average hours worked are assumed to be 0.1, 0.0, and -0.1 percent for the low cost, intermediate, and high cost assumptions, respectively. These ultimate annual rates of change for average hours worked are the same as those assumed for the 2007 report.
The average annual change in the ratio of earnings to compensation was ‑0.2 percent from 1966 to 2006. For wage workers, the assumed ultimate annual rates of change in the ratio of earnings to compensation are -0.1, -0.2, and ‑0.3 percent for the low cost, intermediate, and high cost assumptions, respectively. Under the intermediate assumptions, the ratio of wages to employee compensation is projected to decline from 0.809 for 2007 to 0.698 for 2082. The ratio of compensation to GDP is assumed to be stable.
Thus, the ultimate projected annual growth rate in average U.S. earnings is about 3.9 percent for the intermediate assumptions. This growth rate reflects assumed ultimate annual growth rates of about 1.7, -0.2, 0.0, and 2.4 percent for productivity, the ratio of earnings to compensation, average hours worked, and the GDP deflator, respectively. Similarly, the ultimate projected annual growth rate in average nominal U.S. earnings is 3.4 percent for the low cost assumptions and 4.4 percent for the high cost assumptions.
Over long periods of time the average annual growth rates in average U.S. earnings and average earnings in OASDI covered employment are expected to be very close to the average annual growth rates in the average wage in OASDI covered employment (henceforth the average covered wage). Thus, the assumed ultimate annual growth rates in the average covered wage are 3.4, 3.9, and 4.4 percent for the low cost, intermediate, and high cost assumptions, respectively. For the intermediate assumptions, the annual rate of change in the average covered wage is estimated to be 4.4 percent for 2007, then generally declining until reaching its assumed ultimate annual growth rate of 3.9 percent after 2017.
For simplicity, real increases in the average OASDI covered wage have traditionally been expressed in the form of real-wage differentials—i.e., the percentage change in the average covered wage minus the percentage change in the CPI. This differential is closely related to assumed growth rates in average earnings and productivity, which are discussed in the previous sections. Over the 40-year period, 1967-2006, the real-wage differential averaged 0.9 percentage point, the result of averages of 0.7, 0.7, 0.5, and 1.6 percentage points for the 10-year periods 1967-76, 1977-86, 1987-96, and 1997‑2006, respectively. The assumed ultimate annual average covered real-wage differentials are 1.6, 1.1, and 0.6 percentage point(s) for the low cost, intermediate, and high cost assumptions, respectively.
Based on preliminary data, the real-wage differential is estimated to be 1.6 percentage points for 2007. For the intermediate assumptions, the real-wage differential is projected to fall to 1.3 percentage points in 2008, then rise to 1.7 percentage points in 2009, reflecting an assumed economic slowdown and recovery over the period. The real-wage differential is projected to average about 1.2 percentage points for the 2010 to 2013 period, then average the ultimate assumed differential of 1.1 percentage points (3.9 percent nominal wage growth less 2.8 percent CPI inflation) thereafter.
For the low cost assumptions, the real-wage differential is assumed to rise to 2.1 percentage points by 2009, then generally decline to an average of about 1.5 percentage points over the 2012 to 2017 period, then averaging the ultimate assumed real-wage differential of 1.6 percentage points for 2018 and later. For the high cost assumptions, the real-wage differential for the short-range period is projected to fluctuate between -1.3 and 2.0 percentage points, eventually stabilizing at about 0.6 percentage point for 2018 and later.
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The civilian labor force is projected by age, sex, marital status, and presence of children. Projections of the labor force participation rates for each subgroup take into account the percentages of the
population that are disabled or in the military, the levels of Social Security retirement benefits, the state of the economy, and changes in life expectancy. The projections also include a “lagged-cohort effect” that applies changes in participation rates for a cohort at a specific age (relative to earlier cohorts at the same age) to participation rates for that cohort at older ages.
The annual rate of growth in the size of the labor force decreased from an average of about 2.1 percent during the 1970s and 1980s to about 1.2 percent from 1990 to 2007. Further slowing of labor force growth is projected due to a substantial slowing of growth in the working age population in the future—a natural consequence of the
baby-boom generation approaching retirement and the succeeding lower-birth-rate cohorts reaching working age. Under the intermediate assumptions, the labor force is projected to increase by about 0.8 percent per year, on average, through 2017. Thereafter, the labor force is projected to increase much more slowly, averaging 0.5 percent over the 2017 to 2022 period, and 0.4 percent over the remainder of the 75-year projection period. The 0.4 percent ultimate average annual growth rate in the labor force is higher than the 0.3 percent growth rate in the 2007 Trustees Report because of changes in the demographic assumptions (see section
V.A).
The ultimate projected labor force participation rates are not basic assumptions. They are derived from a historically-based structural relationship using demographic and economic assumptions specific to each alternative. However, the participation rates are not highly sensitive to most of the demographic and economic assumptions. Thus, the projected labor force participation rates vary modestly into the future and across alternatives.
Historically, labor force participation rates have been influenced substantially by trends in demographics and pensions. Between the mid‑1960s and the mid‑1980s, labor force participation rates at ages 50 and over declined for males and were fairly stable for females. These overall declines were facilitated by the large numbers of workers entering the labor force from the baby-boom generation, and from the female population in general, during this period. This increasing supply of labor allowed employers to offer early-retirement options that were attractive. Between the mid‑1980s and about 1995, these rates roughly stabilized for males and increased for females. Since 1995, however, participation rates for both sexes at ages 50 and over have generally risen significantly, reflecting a decrease in early-out options and relatively strong economic growth.
For the future, changes in available benefit levels from Social Security, increases in the normal retirement age, and the effects of modifying the earnings test are expected to encourage work at higher ages. Some of these factors are modeled directly. However, other factors, like the trend away from private defined-benefit pension plans (that often provided incentives to retire) toward defined-contribution plans, are expected to provide additional upward pressure on labor force participation rates. In addition to this shift in private pensions, the aging of the population is expected to both increase the demand for workers and, through improved health associated with greater life expectancy, improve the ability of the older population to work. Longer life expectancy will also increase the amount of assets that will be needed to live comfortably through retirement years, also influencing workers to stay employed longer. In order to account for these effects, which are directly or indirectly related to increases in life expectancy, projected participation rates for prime age and older males and females are adjusted upward in relation to assumed increases in life expectancy. For the intermediate projections, this adjustment for changes related to life expectancy adds about 1.3 percent to the total labor force by 2082.
For men age 16 and over, the projected age-adjusted labor force participation rates for 2082 are 72.6, 73.0, and 73.5 percent for the low cost, intermediate, and high cost assumptions, respectively, compared to the 2006 level of 73.5 percent. (Age-adjusted labor force participation rates are adjusted to the 2006 age distribution of the civilian noninstitutional U.S. population.) These rates reflect the net effect of increases due to assumed improvements in life expectancy, and decreases due to higher assumed disability prevalence rates and an increasing proportion of males who are never married. For women age 16 and over, the projected age-adjusted labor force participation rates for 2082 are 60.6, 60.7, and 60.6 percent, for the low cost, intermediate, and high cost assumptions, respectively, compared to the 2006 level of 59.4 percent. These projections are the net effect of decreases due to higher assumed disability prevalence rates, increases due to assumed improvements in life expectancy, and increases due to assumed changes in the proportion of females who are separated, widowed, divorced, or never married.
The unemployment rate presented in table V.B2 is in the most commonly cited form, the civilian rate. For years through 2017, total rates are presented without adjustment for the changing age-sex distribution of the population. For years after 2017, unemployment rates are presented as total age-sex- adjusted rates (using the age-sex distribution of the 2006 civilian labor force). Age-sex-adjusted rates allow for more meaningful comparisons across longer time periods.
The total unemployment rate reflects the projected levels of unemployment for various age-sex subgroups of the population. The unemployment rate for each subgroup is projected based on a specification (consistent with Okun’s Law) relating changes in the unemployment rate to the changes in the economic cycle, as measured by the ratio of the actual to potential GDP. For each alternative, the total unemployment rate is projected to move toward the ultimate assumed rate as the economy moves toward the long-range sustainable growth path.
The ultimate age-sex-adjusted unemployment rate for each alternative is assumed to be reached by 2017. The ultimate assumed unemployment rates are 4.5, 5.5, and 6.5 percent for the low cost, intermediate, and high cost assumptions, respectively. These are the same values assumed for the 2007 report.
The real growth rate in gross domestic product (GDP) equals the combined growth rates for total employment, productivity, and average hours worked. Total employment is the sum of the U.S. Armed Forces and total civilian employment, which is based on the projected total civilian labor force and unemployment rates. For the 40-year period from 1966 to 2006, the average growth rate in real GDP was 3.1 percent, combining the approximate growth rates of 1.6, 1.7, and ‑0.3 percent for its components—total employment, productivity, and average hours worked, respectively.
For the intermediate assumptions, the average annual growth in real GDP is projected to be 2.4 percent from 2007 to 2017, a slower rate than the 3.1 percent average observed over the historical 40‑year period from 1966 to 2006. This slowdown is primarily due to slower projected growth in total employment. For the low cost assumptions, annual growth in real GDP is projected to average 3.1 percent over the decade ending in 2017. The relatively faster growth is due mostly to a higher assumed rate of growth in worker productivity. For the high cost assumptions, real GDP is assumed to fall in the fourth quarter of 2007 and in the first three quarters of 2008, resulting in a total decline in real GDP for these four quarters of 2.6 percent. After 10 quarters of recovery, a second recession, with a total decline in real GDP of 1.7 percent, is assumed to begin in the second quarter of 2011 and last three quarters. After the second recession, a moderate economic recovery is assumed through 2013, with continued modest economic growth thereafter. For the high cost assumptions, annual growth in real GDP is projected to average 1.7 percent for the decade ending in 2017.
After 2017, no economic cycles are assumed for the three alternatives. Thus, projected rates of growth in real GDP are determined by the projected full-employment rate of growth for total employment, and the assumed full-employment rates of growth for total U.S. economy productivity and average hours worked. For the intermediate assumptions, the projected rate of growth for real GDP falls toward the assumed productivity growth rate because of the projected decline in labor force growth over the period. At the end of the 75‑year projection period, the annual growth in real GDP is 2.1 percent, due to the assumed ultimate percent changes of about 0.4, 1.7, and 0.0 for total employment, productivity, and average hours worked, respectively.
The average annual nominal and real interest rates are presented in table V.B2. The nominal rate is the average of the nominal interest rates for special U.S. Government obligations issuable to the trust funds in each of the 12 months of the year. Interest for these securities is generally compounded semiannually. The real interest rate (ex post) is defined to be the annual compound yield rate for investments in these securities divided by the annual rate of growth in the CPI for the first year after issuance. The real rate shown for each year reflects the actual realized (historical) or expected (future) annual real yield on securities issuable in the prior year.
In developing a reasonable range of assumed ultimate future real interest rates for the three alternatives, historical experience was examined for the 40 years, 1967-2006, and for each of the 10-year subperiods, 1967-76, 1977-86, 1987-96, and 1997-2006. For the 40-year period, the real interest rate averaged 2.8 percent per year. For the four 10-year subperiods, the real interest rates averaged 0.6, 3.7, 4.2, and 2.9 percent, respectively. The assumed ultimate real interest rates are 3.6 percent, 2.9 percent, and 2.1 percent for the low cost, intermediate, and high cost assumptions, respectively. The ultimate real yields, which are assumed to be reached by the end of the short-range period, are the same as those assumed in the 2007 report. These ultimate real interest rates, when combined with the ultimate CPI assumptions of 1.8, 2.8, and 3.8 percent, yield ultimate nominal interest rates of about 5.4 percent for the low cost assumptions, about 5.7 percent for the intermediate assumptions, and about 5.9 percent for the high cost assumptions.
The actual average annual nominal interest rate is 4.8 and 4.7 percent for 2006 and 2007, respectively. The annual rate of change in the CPI is assumed to be 2.8 percent for 2007. Hence, the annual real interest rate is 2.0 percent for 2007. For the next 10-year short-range projection period, nominal interest rates are projected based on changes in the business cycle and in the CPI. Under the intermediate assumptions, the nominal interest rate is projected to rise from 4.7 percent for 2007 to 5.8 percent for 2012 through 2016, reflecting a continued growing economy along with a stable rate of inflation. The nominal interest rate falls to the ultimate assumed level of 5.7 percent for 2017. For the low cost assumptions, the average annual nominal interest rate is assumed to reach an ultimate level of about 5.4 percent for 2013. For the high cost assumptions, it is assumed to peak at 8.8 percent for 2013, and then decline to an ultimate rate of about 5.9 percent by 2016.
