Wednesday, April 6, 2011

Assumptions underlying Social Security Program Projectons

Assumptions Used in CBO’s Analysis

A number of basic assumptions underlie all long-term projections of the Social Security program’s finances. To project overall trends in demographics and disability, CBO adopts the assumptions of the Social Security trustees— specifically, for this analysis, the assumptions in the 2008 trustees’ report on the aggregate fertility rate, the rate of decline in mortality, the level of immigration, and the rates of disability incidence and termination. CBO’s long-term economic assumptions are based on the assumptions used in its baseline budget projections.

Thus, for the first 10 years of the 2008–2082 projection period, CBO used assumptions based on the values of the variables in its February 2008 economic forecast. The assumptions for later years are based on the baseline’s underlying economic assumptions for 2018. (CBO used no specific assumptions about the growth of GDP or taxable payroll but instead computed projected levels of those variables on the basis of more basic economic and demographic assumptions.)

The two most important economic variables for Social Security projections are the rate of growth of earnings and the rate of interest on the U.S. Treasury bonds credited to the trust funds. CBO projects that real earnings will grow at an average annual rate of 1.4 percent over the projection period, an estimate based on four underlying assumptions:

Growth of Labor Productivity. CBO assumed that over the long term, total factor productivity (average real output per unit of combined labor and capital “services”) would grow at a rate of 1.3 percent annually. It then used an economic model to compute the resulting growth in labor productivity (measured as growth in output per hour worked), which is projected to average 1.9 percent annually.

Changes in the Ratio of Taxable Earnings to Total Compensation. CBO assumed that the share of compensation that workers receive as nontaxable health benefits would continue to increase during the 2008–2082 projection period, which would reduce the average rate of growth of taxable earnings. Specifically, CBO assumed that the long-term annual rate of decline in earnings as a share of compensation would slow from about -0.25 percent to about -0.05 percent in 2082, for an average -0.13 percent, a pace that would reduce the projected growth of real wages by the same amount.

Difference Between Growth in the Consumer Price Index and the GDP Deflator. The consumer price index (CPI) and the GDP deflator are two different measures of inflation. The GDP deflator is used for computing measures of total economic growth and therefore the growth of the taxable wage base. However, Social Security benefits are adjusted yearly for inflation by the growth in the CPI for urban wage earners and clerical workers (CPI-W). As a result, when the GDP deflator grows more slowly than the CPI-W, the growth of real earnings is reduced. CBO assumes that the gap, and thus the reduction in real earnings growth, will average 0.3 percentage points.

Growth in Average Hours of Work. CBO assumed that, in general, the number of hours worked by people in the labor force would remain constant. However, different segments of the population work, on average, different numbers of hours. (For example, men tend to work more hours than women, and people in their 30s tend to work more hours than people in their 50s.) As a result, projections of total average hours worked varied slightly because of projected changes in the composition of the labor force. CBO assumed that the real rate of interest on the bonds credited to the Social Security trust funds would be 3.0 percent a year, a figure that it also used for the discount rate in its present-value calculations. In addition, CBO assumed that annual inflation—as measured by growth in the CPI-W—would be 2.2 percent and that the unemployment rate would be 4.8 percent.