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Skriven 2005-02-04 23:33:26 av Whitehouse Press (1:3634/12.0)
Ärende: Press Release (050204c) for Fri, 2005 Feb 4
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CEA Memo on Social Security
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For Immediate Release
Office of the Press Secretary
February 4, 2005

CEA Memo on Social Security




This white paper addresses three questions that have arisen from the debate
surrounding the President's call to save Social Security:
  þ Will Social Security be bankrupt by 2042?
  þ Are projections of future stock returns realistic given the outlook for
    long-term economic growth?
  þ Will economic growth alone be enough to solve the problem?

I. Will Social Security be >bankrupt_ by 2042?

Yes. Bankrupt means >having insufficient assets to cover one's debts,_1
which applies to Social Security in 2042, according to the Social Security
Trustees most recent report.2

Beginning in 2042, the Social Security Trust Fund will be exhausted. At
that point, the resources available to the system (payroll taxes plus some
income taxes on Social Security benefits), will be insufficient to cover
the liabilities of the system (benefits scheduled for retirees, people with
disabilities, and other beneficiaries). If nothing is done to correct this
problem, benefit payments would have to be reduced by roughly 27 percent.

A Small Business Analogy:

Consider a small business that has $750,000 in annual revenue and $1
million in annual costs, for a $250,000 annual loss. Obviously, that
business would be able to stay open only as long as it has enough money in
the bank to cover its losses. Once the money runs out, the business will be
bankrupt. The business won't necessarily disappear, but to stay open it
would have to restructure so that its revenues at least cover its costs.

Likewise, Social Security will begin to incur annual operating >losses_ in
2018, when its outlays first exceed its tax revenues. To cover the
shortfall and to >stay open,_ Social Security will use up its Trust Fund
(or draw down its bank account) from 2018 to 2042. Social Security, like
the small business example above, would be better off if it restructured
before reaching bankruptcy.

Some argue that Social Security will not be bankrupt until it cannot pay
any benefits at all. By that standard, the hypothetical small business
wouldn't be bankrupt either, even as the bank forces it to shutter its
doors.

1 www.Dictionary.com
2 Social Security Trustees Report, page 3

II. Are projections of future stock returns realistic given the outlook for
long-term economic growth?

Yes. The Social Security Actuaries assume that stocks will provide an
average real return of 6.5% per year over the next 75 years. Some argue
that this is unreasonably high if, as the Social Security Trustees predict,
economic growth will average only 1.9% per year in the future. This
argument is incorrect; the stock return and economic growth assumptions are
not inconsistent.

The Actuaries' financial assumptions are consistent with historical
experience and other professional estimates.
  þ The Social Security Trustees estimate future stock returns of 6.5% per
    year in real terms (i.e., above inflation) based on an independent
    review of historical data and economic analyses of future stock
    returns.
  þ To put this projection into context, it is important to compare it with
    the Trustees' forecast of returns on long-term government bonds: 3.0%
    per year in real terms (the average return on long-term bonds in recent
    decades). The Actuaries are thus assuming that stocks will return 3.5%
    more per year than government bonds. This premium is consistent with
    long-run historical experience and is low relative to the experience of
    the last seventy-five years.
  þ In its most recent analyses, the non-partisan Congressional Budget
    Office (CBO) makes similar projections. CBO estimates that the long-run
    real return on government bonds will be 3.3% per year and the real
    return on stocks will be 6.8% per year.
  þ The Actuaries' projection of a 6.5% real stock return is thus
    consistent both with other professional assessments and with historical
    investment returns.

The Trustees predict that economic growth will slow primarily because of
slower population growth. Slower population growth need not imply lower
stock returns.
  þ The Social Security Trustees project that economic growth will slow in
    the future, primarily because of slower population and labor force
    growth. Some observers believe that this growth slowdown will reduce
    future stock returns.
  þ Although short-run movements in growth can affect stock market returns,
    there is no necessary connection between stock returns and economic
    growth in the long run. Long-run economic growth is determined by
    productivity growth and labor force growth here in the United States,
    while stock market returns are determined by the overall cost of
    capital in the global economy and by the return investors require to
    bear the risk that comes with equity ownership. There is no reason to
    believe that slowing population growth in the United States would
    significantly lower the cost of capital, as set by increasingly
    globalized capital markets, or the premium required by stock investors.

III. Will economic growth alone be enough to save Social Security?

No. While economic growth makes it easier to sustain some government
spending programs, this does not apply to Social Security, because Social
Security benefits themselves increase with earnings.

Some commentators have wondered whether the Social Security Trustees have
underestimated future productivity growth and, thereby, future economic
growth. If productivity grows faster than expected, the economy will indeed
grow more rapidly, as will worker wages. But this won't provide that much
help to Social Security. As workers' wages rise, their payments to Social
Security go up, providing a short-term benefit to the program. However,
their future benefits increase as well. Thus, while there is a short-term
benefit to Social Security from economic growth, the long term benefit is
relatively small. It is almost like running on a treadmill_getting ahead
requires more than is reasonable to expect.

Specifically, the indexation of initial Social Security benefits to wages
means that increased benefits offset much of the higher revenue from faster
wage growth. Closing the financial imbalance through higher growth of wages
and incomes would require that productivity growth remain permanently at a
level far above the historical experience. The progressivity of the system
and the fact that benefits paid to existing workers are indexed to prices,
rather than wages, are the reasons that higher wages help to close the
financing gap at all.

The idea that even strong growth of incomes and wages would not be enough
to close the financing gap is clear from the 2004 Report of the Social
Security Trustees. Simulations in the Report indicate that a 0.5 percentage
point increase in real wage growth would improve the 75-year actuarial
balance by 0.54 percentage points of taxable payroll. This would mean a
75-year deficit of 1.35 percentage points instead of the
currently-projected deficit of 1.89 percent of taxable payroll over
2004-78. The date of Trust Fund exhaustion would be pushed back from 2042
to 2048 in this case.

Under the Trustee's central assumptions, closing the entire 75-year
financing gap of 1.89 percent of taxable payroll would require
approximately a 1.75 percentage point increase in real wage growth (1.75 =
0.5 ž 1.89/0.54). This is approximate because the actual impact of wages on
revenues and costs would not be exactly proportional to a single 0.5
percentage point increase in wages. A 1.7 percentage point increase in real
wage growth would require an enormous deviation from the Trustees'
assumptions; lifting real wage growth from 1.1 percent to 2.85 percent
would be nearly a 60 percent increase in real wage growth and nearly a 45
percent increase in nominal wage growth given the assumption of 2.8 percent
inflation.

Holding fixed the Trustee's economic assumptions other than wages, the
increase in real wages corresponds to long-run GDP growth of 3.5 percent
compared to the Trustees' intermediate assumption of 1.8 percent growth,
and 3.3 percent long-run productivity growth compared to the Trustees'
intermediate assumption of 1.6 percent long-run productivity growth. Such
rapid productivity growth would be substantially out of line with the
historical experience that productivity growth has tended to revert to the
historical experience after periods of higher performance. The Trustees
note: >The annual increase in total productivity averaged 1.5 percent over
the last four complete economic cycles (measured from peak to peak),
covering the 34-year period from 1966 to 2000._

The Trustees also report the results of stochastic simulations that
quantify the probability that the Trust Fund will be solvent in the event
that future changes to underlying economic conditions are similar in
magnitude to historical changes. These simulations indicate that there is
less than a 2.5 percent chance that a combination of positive changes in
all of the dimensions they model would lead to long-term balance in the
present Social Security system.

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