Reading tea leaves on Social Security

Trustees' projections to play role in debate over system's future

Author: Charles Stein

Published: March 22, 2005

In the next day or two, the trustees of the Social Security system will try to predict the future.

The trustees - a six-member group of political appointees that oversees Social Security - are scheduled to issue their annual report in which they lay out their view of the next 75 years, including their estimate for when the system will run out of money and how large a deficit Social Security faces.

A year ago the trustees predicted the system would be solvent until 2042. If their projections change, the news will almost certainly become part of the political debate over Social Security?s fate. Democrats will seize on any improvement in Social Security?s finances as evidence that the program doesn?t need a major overhaul. Republicans will regard any deterioration as a sign that reform is required now.

But as Ronald Lee, a demographer at the University of California at Berkeley points out, the numbers are all just educated guesses.

??No one knows what the future will look like,?? said Lee. ??There is a huge band of uncertainty.??

Lee, for example, thinks the trustees have been too conservative about the prospects for longevity. If he is right, and Americans live longer - and draw Social Security checks for longer - the Social Security system could run out of money sooner than predicted.

Dean Baker takes a different view. Baker, the co-director of the Center for Economic and Policy Research, a Washington think tank, says the trustees have too gloomy a view of the economy?s potential. Using more optimistic assumptions about immigration and growth than the trustees have used, Baker argues that Social Security will have enough money to pay benefits well beyond 2042.

No matter what estimates they use, most of the economists and demographers who study Social Security agree on two things: that the system?s projections represent a good-faith attempt to see into the future and that it is highly unlikely the outlook will change radically enough to eliminate the Social Security shortfall altogether.

??We are not going to be saved by changing assumptions,?? said Alicia Munnell, director of the Boston College Center for Retirement Research.

Gauging Social Security?s financial health is a massive exercise in number crunching. The statistics fall into two broad categories: economic and demographic. On the economic side, Social Security?s actuaries have to make a forecast for a list of factors including wage growth, inflation, and the percentage of the population that will be in the labor force. When it comes to demographics, they have to look at birth rates, immigration, and lifespan.

As a general rule, a larger workforce and higher wages help Social Security because the system collects more in taxes, which leaves more money to pay benefits. Higher inflation hurts Social Security because benefits are indexed to inflation. Greater longevity also hurts Social Security because it means the government has to pay out benefits for more years.

??Only in government programs could we complain that living longer creates problems,?? joked Eugene Steuerle, an economist with the Urban Institute, a Washington think tank.

Critics of the assumptions tend to focus on a few variables. One is productivity, a measure of output per worker and a key driver of wages. Higher productivity usually translates into higher wages. In their last annual report, the trustees estimated that productivity would grow 1.6 percent a year for the foreseeable future. Baker calls that assumption ??extraordinarily pessimistic.??

Over the past five years, productivity growth in the United States averaged 3.6 percent a year, a stellar performance that may have something to do with increased use of computers. On the other hand, from 1962 to 2002 productivity grew 1.7 percent annually, roughly in line with the trustees? estimate.

Will the future of productivity look like the recent past or the longer-term past? No one knows, but again the answer matters. Using the 1.6 percent estimate, the system?s trust fund runs out of money in 2042. With a 1.9 percent estimate, a forecast the actuaries consider optimistic, the trust fund lasts until 2048. The trust fund holds the surplus that has built up in the Social Security system over the past two decades.

Rudolph Penner, an Urban Institute economist, concedes that more robust economic growth helps Social Security?s finances. Yet in a recent paper, Penner cautioned that over the long haul ??higher growth has only a modest beneficial impact.?? The reason: That same higher growth eventually translates into higher Social Security benefits since benefit levels are linked to wages. Put another way, what a good economy gives with one hand, it eventually takes away with the other.

On the demographic side, the trustees forecast that longevity will increase gradually over the next 75 years. Male life expectancy, currently 74.7 years, is projected to rise to 81.6 by 2080. Female life expectancy is set to rise from 79.6 to 85.3. The gains, while impressive, represent a slower pace of improvement than has been achieved in the past. Some demographers think that widespread obesity will contribute to that slowdown.

On the other hand, Richard Suzman, a specialist on aging at the National Institutes of Health, said the Social Security outlook could conceivably prove too conservative. Suzman said that over the past 160 years, lifespans have increased steadily and that there is no indication yet that progress is diminishing. He notes further that in Europe and Japan people already live longer than they do in America.

??There is plenty of headroom left for us to expand,?? he said.

With a more aggressive forecast for lifespans - a hypothetical exercise Social Security actuaries conduct on all the key variables in their forecast - the trust fund runs out of money in 2039, instead of 2042.

Gary Burtless, an economist at the Brookings Institution, a Washington think tank, said it is possible that the economy will do better than predicted, but that Americans also will live longer. The upshot: ??The errors on each side could cancel each other out,?? he said.

In which case, Social Security?s financial future would remain rocky.