For Immediate Release: January 26, 2000
The latest projections by the Congressional Budget Office (CBO) show a very different picture for the Social Security program than what is assumed in the most recent Social Security trustees' report. The CBO projections for the next ten years show a cumulative surplus that is more than twice as high as the projection in the 1999 Social Security trustees' report. Furthermore, CBO assumes a rate of long-term economic growth that may leave Social Security fully solvent for almost 50 years into the future.
At the same time that CBO's numbers suggest a much brighter picture for Social Security, the profit projections are not good news for Wall Street. CBO projects that before-tax corporate profits will actually shrink by 3.8 percent in real terms over the next decade. It predicts that after-tax corporate profits will shrink by a slightly larger amount, declining 4.8 percent in real terms from 1999 to 2010.
The 1999 trustees' report projected that the trust fund would grow by $1099.8 billion from the end of 1999 to the end of 2010. CBO is now projecting that the fund will grow by $2,471 billion over this period, almost two and a half times as much. The annual gap between the two projections grows over this period. For the year 2010, the gap in projections is almost $90 billion, with the Social Security trustees forecasting a surplus for the year of $206.3 billion, while CBO is projecting a Social Security surplus in 2010 of $295 billion.
The main reason for the huge difference in the projections for the Social Security trust fund has to do with differing projections for economic growth. In their most recent report, the trustees assumed that the economy would grow at an average annual rate of just 2.0 percent over the next decade. In contrast, CBO is projecting an average growth rate of 2.8 percent over this period. This is because the Social Security trustees have held their growth projections constant, even as changes in measurement and evidence of stronger growth have led CBO and other forecasters to raise their growth projections.
Part of the reason for the higher CBO growth projection over this period is due to more rapid labor force growth, but most of it is due to a higher projected rate of productivity growth. The trustees assumed that productivity growth would average just 1.35 percent annually. CBO now projects that the long-term rate of productivity growth for the economy is 1.9 percent, approximately the same as the rate of productivity growth in western Europe in recent decades. Over the long term, the rate of productivity growth will have far more impact on Social Security's finances (as well as future living standards) than the rate of labor force growth over the next decade.
If the projections from CBO turn out to be more accurate, then the Social Security trust fund will be significantly stronger than is indicated in the trustees' report. The growth rate projected by CBO would extend the projected date of the trust fund's depletion well past 2040, and possibly close to 2050. The CBO numbers suggest that "saving" Social Security is a much less urgent task than was suggested by the trustees in their last report.
The latest profit projections are somewhat lower than what had appeared in CBO's last report. CBO is projecting that before-tax profits will rise by just 26.2 percent, in nominal terms, over the period from 1999 to 2010. It projects that nominal after-tax profits will rise by 24.9 percent. As indicated before, both are projected to decline after adjusting for inflation.
These profit projections are radically at odds with what the stock market appears to be assuming. It is virtually impossible to see how stocks will be able to produce returns that are anywhere close to their historic average if these profit projections prove accurate. This can be shown with a simple arithmetic calculation.
The return on stocks is equal to the annual dividend payout plus the capital gain. Because current price to earnings ratios in the stock market are at record highs, the dividend payout rates are at record lows. Currently the dividend payout rate is approximately 1.5 percent of share prices (this figure includes money used to buy back shares as dividend payouts). This means that in order to provide the 7.0 percent historic rate of real return on stocks, real stock prices would have to rise by 5.5 percent annually (7.0 percent, minus the 1.5 percent dividend payout). Given the decline in profits assumed by CBO, this would imply that the price to earnings ratio would rise from approximately 30 to 1 at present to almost 60 to 1 by 2010. Even if the real returns in the market averaged just 6.0 percent over the next decade, the CBO profit projections would still imply a price to earnings ratio of 52 to 1 in 2010. There are few, if any, economists or market analysts who view such price to earnings ratios as plausible. Clearly, investors in the market have a very different view of the economy than the economists at the Congressional Budget Office.