In their 2012 report on the US Social Security system, the trustees present results of financial projections extending to 2086. These include the actuarial balances of the system over various projection periods, including 25, 50 and 75 years, on three different sets of economic and demographic assumptions. The actuarial balance is derived as the difference between (a) the value of future income and the current assets of the system and (b) the value of future benefits and other expenses together with a minimum reserve of one year’s benefit outgo. The ratio of the value of this future income and assets to future benefits and expenses (without the minimum reserve) represents the system’s solvency ratio. While the actuarial balance as a percentage of taxable payroll reported by the trustees is a measure of the financial status of the system, it does not indicate the relative solvency of the system as measured by the percentage which the assets-plus-income represents compared to the benefits-plus-expense-outgo stream.
The 2012 report states that the 75-year actuarial balance deteriorated compared to 2011, increasing the deficit from 2.22% to 2.67% of taxable payroll. On a solvency basis, without the minimum reserve, the 75-year deficit amounts to 2.52% of taxable payroll; this means that full 100% solvency until 2086 could be achieved by increasing the payroll tax rate for employers and employees from 6.2% to about 7.5%. The system has a solvency ratio in excess of 100% until 2033, and solvency ratios projected at 96% for 25 years, 88% for 50 years, and 85% for 75 years. In addition to the standard intermediate scenario, the report presents results on low and high cost scenarios. These alternative projections are based on more and less favorable sets of economic and demographic assumptions respectively. They are generally interpreted as representing the outer limits of a range 2012of plausible outcomes. For the optimistic scenario, the solvency ratios for 25, 50 and 75 years are 107%, 100% and 100% respectively. For the pessimistic scenario, the corresponding solvency ratios are 86%, 76% and 71% respectively.
75-year projections are inherently only estimates of potential future outcomes. However, these projections are often misinterpreted as precise indicators of the system’s financial condition, while the range of outcomes between the low-cost and high-cost estimates is generally disregarded. It is important to focus attention on the full spectrum of potential outcomes, because the range of these outcomes is large, reflecting the degree of uncertainty associated with the results. From the results in the 2012 report the difference in the solvency ratios as between the low-cost and the high-cost results is 21% at 25 years, 24% at 50 years and 29% at 75 years. These differences indicate the substantial degree of uncertainty associated with the intermediate estimates; they also increase significantly as the length of the projection period increases, making the longer-term projections far less reliable for policymaking decisions about appropriate levels of contributions and benefits.
The trustees provide detailed explanations for the reason that the projected long-range financial position has deteriorated. Apart from a small increase in the deficit due to a change in the projection period to include the year 2086 within the 75-year horizon, all of the remaining increase is attributable to changes in the economic and demographic assumptions adopted by the trustees about future expected experience. Not surprisingly, recent adverse economic experience that has impacted financial and employment conditions, when incorporated in the baseline and short-term assessment for the future, produces results that compare unfavorably with previous expectations. This situation reinforces the view that financing Social Security with fixed payroll tax rates in a dynamically-changing economic and demographic environment requires greater flexibility. Conceptually, the financing method needs to be dynamically responsive to changing economic and demographic conditions. However, from a practical standpoint, it would be inappropriate to introduce a system of enhanced fixed (but adjustable from time to time) payroll tax rates that might fluctuate significantly over time in response to changing economic and demographic conditions. One possibility that merits consideration would be to incorporate a supplement to the fixed-rate payroll tax revenue stream with additional funding from general tax revenues so as to achieve specified target solvency levels over 50 and 75 years. This supplemental solvency and sustainability funding could be determined as a small percentage of GDP. This would have the effect of stabilizing the financial condition of the system and avoiding hardship arising from potential future benefit reductions. In terms of affordability, the trustees project that the ongoing long-term cost of funding the Social Security system will stabilize at around 6% of GDP. The gap between this amount and the projected revenue stream under the existing arrangements would, of course, need to be assessed against other discretionary federal budget and national expenditure priorities including health care and national security.