INTRODUCTION

When the Social Security program was signed into law on August 14, 1935 it carried a provision that created the first Social Security Trust Fund and set forth a Board of Directors to oversee its operation.  The Trust funds were deemed necessary as a cushion to allow payments between the quarterly deposits of FICA payroll tax. 

The Board is composed of six members, four of whom serve automatically by virtue of their positions in the Federal Government: the Secretary of the Treasury, who is the Managing Trustee, the Secretary of Labor, the Secretary of Health and Human Services, and the Commissioner of Social Security. The other two members are appointed by the President and confirmed by the Senate to serve as public representatives.

The Board of Trustees reports each year on the current and projected financial condition of the Social Security program, which is financed through two separate trust funds. The Old-Age and Survivors Insurance (OASI) Trust Fund pays monthly benefits to retired workers and their families and to survivors of deceased workers. The Disability Insurance (DI) Trust Fund pays monthly benefits to disabled workers and their families.

The report on the current financial status of the funds includes an accounting of the actual income and expenditures for the last year. The projections for future years reflect the Trustees' considered judgment about all the demographic, economic, and program factors that affect income and expenditures. Projections are presented separately for the next 10 years (the short range) and for the next 75 years (the long range). All projections are based on current Social Security law and do not anticipate any future changes that Congress might make.

Because any projection of future experience is uncertain, the Trustees use three alternative sets of assumptions to show a range of possible outcomes. The intermediate set of assumptions, designated as alternative II, reflects the Trustees' best estimate of the trust funds' future financial outlook; the low cost alternative I is more optimistic, and the high cost alternative III more pessimistic. This writing is based on the 2004 Trustees report and will focus on the most likely assumptions, alternative II.

For the 2004 report, moving the valuation date from 2003 to 2004 has increased the program's actuarial deficit and unfunded obligation. Demographic, economic, and programmatic factors have also been updated with the most recently available information. Compared to the results shown in last year's report, projected annual balances for the Social Security program (income minus costs) are somewhat improved for years after about 2045. Overall, the projected financial status of the program shows little change.

OVERVIEW

HIGHLIGHTS

The report's major findings are summarized below.

In 2003

At the end of 2003, 47 million people were receiving benefits: 33 million retired workers and their dependents, 7 million survivors of deceased workers, and 8 million disabled workers and their dependents. During the year an estimated 154 million people had earnings covered by Social Security and paid payroll taxes. Total benefits paid in 2003 were $471 billion. Income was $632 billion, and assets held in special issue U.S. Treasury securities grew to $1.5 trillion.

Short-Range Results

The OASI and DI Trust Funds, individually and combined, are adequately financed over the next 10 years under the intermediate assumptions. The combined assets of the OASI and DI Trust Funds are projected to increase from $1,531 billion at the beginning of 2004, or 306 percent of annual expenditures, to $3,584 billion at the beginning of 2013, or 442 percent of annual expenditures in that year. Combined assets were projected in last year's report to rise to 309 percent of annual expenditures at the beginning of 2004, and 461 percent at the beginning of 2013.

Long-Range Results

Under the intermediate assumptions the combined OASI and DI Trust Funds are projected to become exhausted in 2042. For the 75-year projection period, the actuarial deficit is 1.89 percent of taxable payroll, 0.03 percentage point smaller than in last year's report. The open group unfunded obligation for OASDI over the 75-year period is $3.7 trillion in present value, $0.2 trillion more than the obligation estimated a year ago.

Between about 2010 and 2030, OASDI cost will increase rapidly due to the retirement of the large baby-boom generation. After 2030, increases in life expectancy and relatively low fertility rates will continue to increase Social Security system costs, but more slowly. Annual cost will exceed tax income starting in 2018 at which time the annual gap will be covered with cash from redeeming special obligations of the Treasury, until these assets are exhausted in 2042. Separately, the DI fund is projected to be exhausted in 2029 and the OASI fund in 2044.

Solvency

The combined OASDI Trust Funds are projected to become insolvent (i.e., unable to pay scheduled benefits in full on a timely basis) when assets are exhausted in 2042 under the long-range intermediate assumptions. For the trust funds to remain solvent throughout the 75-year projection period, the combined payroll tax rate could be increased during the period in a manner equivalent to an immediate and permanent increase of 1.89 percentage points, benefits could be reduced during the period in a manner equivalent to an immediate and permanent reduction of 12.6 percent, general revenue transfers equivalent to $3.7 trillion (in present value) could be made during the period, or some combination of approaches could be adopted. Significantly larger changes would be required to maintain solvency beyond 75 years.

TRUST FUND FINANCIAL OPERATIONS IN 2003

The table below shows the income, expenditures, and assets for the OASI, the DI and the combined OASDI Trust Funds in calendar year 2003.

Note: Totals do not necessarily equal the sums of rounded components.

In 2003, net contributions accounted for 84 percent of total trust fund income. Net contributions consist of taxes paid by employees, employers and the self-employed on earnings covered by Social Security. These taxes were paid on covered earnings up to a specified maximum annual amount, which was $87,000 in 2003 and is increased each year automatically (to $87,900 in 2004) as the average wage increases. The tax rates scheduled under current law for 2003 and later are shown in table 2.

Two percent of OASDI Trust Fund income came from subjecting up to 50 percent of Social Security benefits above a certain level to Federal personal income taxation, and 13 percent of OASDI income came from interest earned on investment of OASDI Trust Fund reserves. Social Security's assets are invested in interest-bearing securities of the U.S. Government. In 2003 the combined trust fund assets earned interest at an effective annual rate of 6.0 percent. More than 98 percent of expenditures from the combined OASDI Trust Funds in 2003 went to pay retirement, survivor, and disability benefits totaling $470.8 billion. The financial interchange with the Railroad Retirement program resulted in a payment of $3.7 billion from the combined OASDI Trust Funds, or about 0.8 percent of total expenditures. The administrative expenses of the Social Security program were $4.6 billion, or about 1.0 percent of total expenditures.

Assets of the trust funds provide a reserve to pay benefits whenever expenditures exceed income. Assets increased by $152.8 billion in 2003 because income to each fund exceeded expenditures. At the end of 2003, the combined assets of the OASI and the DI Trust Funds were 306 percent of estimated expenditures for 2004.

ASSUMPTIONS ABOUT THE FUTURE

The actual future income and expenditures of the OASI and DI Trust Funds depend on many factors, including the size and characteristics of the population receiving benefits, the level of monthly benefit amounts, the size of the work force, and the level of workers' earnings. These factors will depend in turn upon future birth rates, death rates, immigration, marriage and divorce rates, retirement-age patterns, disability incidence and termination rates, productivity gains, wage increases, inflation, and many other demographic, economic, and program-specific factors.

Assumptions are reexamined each year in light of recent experience and new information. This careful review and updating of the assumptions on an annual basis helps ensure that they provide the Trustees' best estimate of future possibilities.

PROJECTIONS OF FUTURE FINANCIAL STATUS

Short-Range Actuarial Estimates

For the short range (2004-2013), the Trustees measure trust fund adequacy by comparing assets at the beginning of each year to projected program cost for that year under the intermediate set of assumptions. Having a trust fund ratio of 100 percent or more--that is, assets at the beginning of each year at least equal to projected outgo during the year--is considered a good indication of a trust fund's ability to cover most short-term contingencies. Both the OASI and the DI trust fund ratios under the intermediate assumptions exceed 100 percent throughout the short-range period and therefore satisfy the Trustees' short-term test for financial adequacy. Figure 3 below shows the trust fund ratios for the combined OASI and DI Trust Funds for the next 10 years.

Long-Range Actuarial Estimates

The financial status of the trust funds over the next 75 years is measured in terms of cost and income as a percentage of taxable payroll, trust fund ratios, the actuarial balance (also as a percentage of taxable payroll), and the open group unfunded obligation (expressed in present-value dollars).

The year-by-year relationship between income and cost rates shown in figure 4 illustrates the expected pattern of cash flow for the OASDI program over the full 75-year period. Under the intermediate assumptions, the OASDI cost rate is projected to decline slightly between 2004 and 2007 and then increase up to the current level within the next 3 years. It then begins to increase rapidly and first exceeds the income rate in 2018, producing cash-flow deficits thereafter. Despite these cash-flow deficits, beginning in 2018, redemption of trust fund assets will allow continuation of full benefit payments on a timely basis until 2042, when the trust funds will become exhausted. This redemption process will require a flow of cash from the General Fund of the Treasury. Pressures on the Federal Budget will thus emerge well before 2042. Even if a trust fund's assets are exhausted, however, tax income will continue to flow into the fund. Present tax rates would be sufficient to pay 73 percent of scheduled benefits after trust fund exhaustion in 2042 and 68 percent of scheduled benefits in 2078.

Social Security's cost rate generally will continue rising rapidly through about 2030 as the baby-boom generation reaches retirement age. Thereafter, the cost rate is estimated to rise at a slower rate for about 15 years as the baby boom ages and begins to decrease in size. Continued reductions in death rates and relatively low birth rates will cause a significant upward shift in the average age of the population and will push the cost rate above 19 percent of taxable payroll by 2078 under the intermediate assumptions.

In a pay-as-you-go system such as OASDI, this 19-percent cost rate means the combination of the payroll tax (scheduled to total 12.4 percent) and proceeds from income taxes on benefits (expected to be 1.0 percent of taxable payroll in 2078) would have to equal more than 19 percent of taxable payroll to pay all currently scheduled benefits. After 2078, the upward shift in the average age of the population is likely to continue and to increase the gap between OASDI costs and income.

The primary reason that the OASDI cost rate will increase rapidly between 2010 and 2030 is that, as the large baby-boom generation born in the years 1946 through 1964 retires, the number of beneficiaries will increase much more rapidly than the number of workers. The estimated number of workers per beneficiary is shown in figure 5. In 2003, there were about 3.3 workers for every OASDI beneficiary. The baby-boom generation will have largely retired by 2030, and the projected ratio of workers to beneficiaries will be only 2.2 at that time. Thereafter, the number of workers per beneficiary will slowly decline, and the OASDI cost rate will continue to increase.

The maximum projected trust fund ratios for the OASI, DI, and combined funds appear in table 6. The chart also contains the year in which the maximum projected trust fund ratio is attained and the years in which the assets are projected to be exhausted.

The actuarial balance is a measure of the program's financial status for the 75-year valuation period as a whole. It is essentially the difference between income and cost of the program expressed as a percentage of taxable payrolls over the valuation period. This single number summarizes the adequacy of program financing for the period. When the actuarial balance is negative, the actuarial deficit can be interpreted as the percentage that would have to be added to the current law income rate in each of the next 75 years, or subtracted from the cost rate in each year, to bring the funds into actuarial balance. In this report, the actuarial balance under the intermediate assumptions is a deficit of 1.89 percent of taxable payroll for the combined OASI and DI Trust Funds. The actuarial deficit was 1.92 percent in the 2003 report and has been in the range of 1.86 percent to 2.23 percent for the last ten reports.

Even a 75-year period is not long enough to provide a complete picture of Social Security's financial condition. Overemphasis on summary measures for a 75-year period can lead to incorrect perceptions and to policy prescriptions that do not move toward a sustainable system. Thus, careful consideration of the trends in annual deficits and unfunded obligations toward the end of the 75-year period is important. In order to provide a more complete description of Social Security's very long-run financial condition, the Trustees Report also includes summary measures for a time period that extends to the infinite horizon. These calculations show that extending the horizon beyond 75 years continues to increase the unfunded obligation, indicating that much larger changes would be required to achieve solvency over the infinite future as compared to changes needed to balance 75-year period summary measures.

Uncertainty of the Projections

Significant uncertainty surrounds the intermediate assumptions. The Trustees have traditionally used low cost (alternative I) and high cost (alternative III) assumptions to indicate this uncertainty. Figure 7 shows the projected trust fund ratios for the combined OASI and DI Trust Funds under the intermediate, low cost, and high cost assumptions. The low cost alternative is characterized by assumptions that improve the financial condition of the trust funds, including a higher fertility rate, slower improvement in mortality, a higher real-wage differential, and lower unemployment. The high cost alternative, in contrast, features a lower fertility rate, more rapid declines in mortality, a lower real-wage differential, and higher unemployment.

These three alternatives have traditionally been constructed to provide a reasonable range of possible future experience. However, these alternatives do not address the probability that actual experience will be within or outside the range. As an additional way of illustrating uncertainty, the Trustees Report includes estimates from a model of the trust funds that provides a probability distribution of possible future outcomes. The results of this model suggest that outcomes better than the traditional low cost alternative and outcomes worse than the high cost alternative have very low probabilities of occurring.

CONCLUSION

Under current law the cost of Social Security will increase faster than the program's income, because of the aging of the baby-boom generation, expected continuing low fertility, and increasing life expectancy. Based on the Trustees' best estimate, program cost will exceed tax revenues starting in 2018 and throughout the remainder of the 75-year projection period. Social Security's combined trust funds are projected to allow full payment of benefits until they become exhausted in 2042. At that time annual tax income to the trust funds is projected to equal about 73 percent of program costs. Separately, the OASI and DI funds are projected to have sufficient funds to pay full benefits on time until 2044 and 2029, respectively. By 2078, however, annual tax income is projected to be only about two-thirds as large as the annual cost of the OASDI program.

Over the full 75-year projection period the actuarial deficit estimated for the combined trust funds is 1.89 percent of taxable payroll--slightly lower than the 1.92 percent deficit projected in last year's report. This deficit indicates that financial adequacy of the program for the next 75 years could be restored if the Social Security payroll tax were immediately and permanently increased from its current level of 12.4 percent (for employees and employers combined) to 14.29 percent. Alternatively, all current and future benefits could be immediately reduced by about 13 percent. Other ways of reducing the deficit include making transfers from general revenues or adopting some combination of approaches.

• If no action were taken until the combined trust funds become exhausted in 2042, much larger changes would be required. For example, payroll taxes could be raised to finance scheduled benefits fully in every year starting in 2042. In this case, the payroll tax would be increased to 16.91 percent at the point of trust fund exhaustion in 2042 and continue rising to 18.31 percent in 2078.
• Similarly, benefits could be reduced to the level that is payable with scheduled tax rates in every year beginning in 2042. Under this scenario, benefits would be reduced 27 percent at the point of trust fund exhaustion in 2042, with reductions reaching 32 percent in 2078.

Changes of this magnitude would eliminate the actuarial deficit over the 75-year period through 2078. However, because of the increasing average age of the population, Social Security's annual cost will very likely continue to exceed tax revenues after 2078. As a result, ensuring the sustainability of the system beyond 2078 would require even larger changes than those needed to restore actuarial balance for the 75-year period.

The projected trust fund deficits should be addressed in a timely way to allow for a gradual phasing in of the necessary changes and to provide advance notice to workers. The sooner adjustments are made the smaller and less abrupt they will have to be. Social Security plays a critical role in the lives of over 47 million beneficiaries, and 156 million covered workers and their families. With informed discussion, creative thinking, and timely legislative action, we will ensure that Social Security continues to protect future generations.

For further information related to the contents of this report, see the following websites.

• www.socialsecurity.gov/OACT/TR/TR04/index.html
• www.cms.hhs.gov/publications/trusteesreport/
• www.treas.gov/offices/economic-policy/social_security.html

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