The Social Security Administration's Cracked Crystal Ball

John Miller

2042. That's the year the Social Security Trust Fund will run out of money, according to the Social Security Administration (SSA). But its doomsday prophesy is based on overly pessimistic assumptions about our economic future: The SSA expects the U.S. economy to expand at an average annual rate of just 1.8% from 2015 to 2080—far slower than the 3.0% average growth rate the economy posted over the last 75 years.

What's behind the gloomy growth projections? Is there anything to them—or has the SSA's economic crystal ball malfunctioned?

Flawed Forecast

The Social Security Administration foresees a future of sluggish economic growth in which labor productivity, or output per worker, improves slowly; total employment barely grows; and workers put in no additional hours on the job. (It reasons that economic growth, or growth of national output, must equal the sum of labor productivity increases, increases in total employment, and increases in the average hours worked.)

In its widely cited "intermediate" 1.8% growth scenario, labor productivity improves by just 1.6% a year and workforce growth slows almost to a standstill at 0.2% a year—rates well below their historical averages. (See Table 1, below.) Under these assumptions, and if average work time holds steady, Social Security exhausts its trust fund in the year 2042, at which point it faces an initial shortfall of 27% of its obligations. After that, Social Security would be able to pay out just 70% of the benefits it owes to retirees.

The problem is not with the logic of the method the Social Security Administration uses to make its projections, but rather with its demographic and economic assumptions. Its forecast of 1.6% annual labor productivity growth is especially suspect. When the nonpartisan Congressional Budget Office (CBO) assessed the financial health of Social Security earlier this year, it assumed that productivity would improve at a rate of 1.9% per year. In the CBO forecast, faster productivity growth, along with a lower unemployment rate, boosts wages—the tax base of the system—allowing Social Security to remain solvent until 2052, 10 years longer than the SSA had projected just a few months earlier.

One doesn't have to buy into the hype about the magic of the new economy to conclude that the CBO came closer to getting the projected productivity growth rates right than the SSA did. The federal government's own Bureau of Labor Statistics estimates that productivity rates in the nonfarm sector improved at a 2.3% average pace from 1947 through 2003. Adjusting for the gap of 0.2 percentage points between the productivity growth of the nonfarm business sector and the economy as a whole still leaves productivity across the economy growing by a healthy 2.1% over the postwar period. That historical record convinces economist Dean Baker, from the Washington-based Center for Economic and Policy Research, that a productivity growth rate of 2.0% a year is a "very reasonable" assumption.

The drastic deceleration of employment growth, from its historic (1960 to 2000) average of 1.78% to 0.2% per year, is also overstated. As the trustees see it, employment will grow far more slowly as the baby-boomers leave the labor force. That is true as far as it goes. But if their projections are correct, the country will soon face a chronic labor shortage. And in that context, the immigration rate is unlikely to slow, as they assume, to 900,000 a year. Rather, future immigration rates would likely be at least as high as they were in the 1990s, when 1.3 million people entered the United States annually, and possibly even higher if immigration laws are relaxed in response to a labor shortage. Faster immigration would boost employment growth and add workers, who would pay into Social Security, helping to relieve the financial strain on the system created by the retirement of the baby-boom generation.

In its own optimistic or "low cost" scenario, the SSA erases the shortfall in the trust fund by assuming a faster productivity growth rate (of 1.9%), a lower unemployment rate (of 4.5% per year), and higher net immigration (of 1.3 million people per year). The still rather sluggish 2.6% average growth rate that results would wipe out the rest of the imbalance in the system and leave a sizeable surplus in the trust fund—0.15% of GDP over the next 75 years.

Making Short Work of the Shortfall

Even in the unlikely event that the pessimistic predictions the SSA has conjured up actually do come to pass, the Social Security imbalance could be easily remedied.

The Social Security Trust Fund needs $3.7 trillion to meet its unfunded obligations over the next 75 years. That is a lot of money—about 1.89% of taxable payroll and about 0.7% of GDP over that period. But it's far less than the 2.0% of GDP the 2001 to 2003 tax cuts will cost over the next 75 years if they are made permanent. (Many of the tax cuts are currently scheduled to sunset in 2010.) The portion of the Bush tax cuts going to the richest 1% of taxpayers alone will cost 0.6% of GDP—more than the CBO projected shortfall of 0.4% of GDP.

Here are a few ways to make short work of any remaining shortfall without cutting retirement benefits or raising taxes for low- or middle-income workers. First, newly hired state and local government workers could be brought into the system. (About 3.5 million state and local government workers are not now covered by Social Security.) That move alone would eliminate about 30% of the projected deficit.

In addition, we could raise the cap on wages subject to payroll taxes. Under current law, Social Security is funded by a payroll tax on the first $87,900 of a person's income. As a result of this cap on covered income, the tax applies to just 84.5% of all wages today—but historically it applied to 90%. Increasing the cap for the next decade so that the payroll tax covers 87.3% of all wages, or halfway back to the 90% standard, would eliminate nearly one-third of the SSA's projected deficit.

Finally, stopping the repeal of the estate tax, a tax giveaway that benefits only the richest taxpayers, would go a long way toward closing the gap. Economists Peter Diamond and Peter Orszag, writing for The Century Fund, advocate dedicating the revenues generated by renewing the estate tax to the Social Security Trust Fund. They suggest an estate tax set at its planned 2009 level, which would exempt $3.5 million of an individual's estate. The tax would fall exclusively on the wealthiest 0.3% of taxpayers. That alone would close another one-quarter of the SSA's projected shortfall. Returning the estate tax to its 2001 (pre-tax cut) level (with a $675,000 exemption for individuals) would do yet more to relieve any financial strain on Social Security.

Any way you look at it, Social Security can remain on sound financial footing even in the dreariest of economic futures, so long as alarmist reports like those of its trustees don't become an excuse to corrupt the system.

John Miller teaches economics at Wheaton College and is a member of the Dollars & Sense collective.

Sources  Congressional Budget Office, The Outlook for Social Security, June 2004; Social Security Administration, 2004 Annual Report of the Board of Trustees (March 23, 2004); "What the Trustees' Report Indicates About the Financial Status of Social Security," Robert Greenstein, Center on Budget and Policy Priorities (March 31, 2004); "The Implications of the Social Security Projections Issued By the Congressional Budget Office" Robert Greenstein, Peter Orszag, and Richard Kogan, Center on Budget and Policy Priorities (June 24, 2004); "Letter to Rudolph G. Penner" from Dean Baker, co-director of the Center For Economic and Policy Research (January 26, 2004); Countdown to Reform: The Great Social Security Debate, Henry Aaron and Robert Reischauer, The Century Foundation Press, 1998.

 

Table 1: Social Security Administration’s Principal Economic Assumptions^a

	Annual Percentage Increase
Year	Real Gross Domestic Productb	Productivity (Total U.S. Economy)	Total Employmentc	Average Hours Worked
2004	4.4%	2.7%	1.7%	0.0%
2005	3.6%	1.8%	1.7%	0.0%
2006	3.2%	1.9%	1.3%	0.0%
2007	3.0%	1.9%	1.1%	0.0%
2008	1.0%	1.8%	2.8%	0.0%
2009	2.7%	1.8%	0.9%	0.0%
2010	2.6%	1.7%	0.8%	0.0%
2011	2.4%	1.7%	0.8%	0.0%
2012	2.3%	1.6%	0.6%	0.0%
2013	2.2%	1.6%	0.6%	0.0%
	Average Annual Percentage Increase
2010 to 2015	2.2%	1.6%	0.6%	0.0%
2015 to 2080	1.8%	1.6%	0.2%	0.0%

^a These are the "intermediate economic assumptions" that the Social Security Administration regards as most plausible. The SSA also reports a "low cost" forecast that projects a 2.6% real growth rate from 2015 to 2080 and a "high cost" forecast that projects a 1.1% real growth rate from 2015 to 2080.

^b Real Gross Domestic Product is calculated in constant 1996 dollars.

^c Total employment is the total of civilian and military employment in the U.S. economy.

Source: Social Security Administration, 2004 Annual Report of the Board of Trustees (March 23, 2004), Table V.B.1 and Table V.B.2, pp. 89 and 94.