Age Dependency Ratios and Social Security Solvency
Released: 2006-10-27T00:00:00

Background

Social Security's financing problems ... are very large and serious. People are living longer, the first baby-boomers are nearing retirement, and the birth rate is low. The result is that the worker-to-beneficiary ratio has fallen from 16.5-to-1 in 1950 to 3.3-to-1 today. Within 40 years it will be 2-to-1. At this ratio there will not be enough workers to pay scheduled benefits at current tax rates.

As highlighted by the Social Security Administration (SSA), the aging of the (United States) population, hastened by the impending retirement of the huge baby-boom generation, has caused policy-makers to question whether the U.S. Social Security system can meet the demands for retirement benefits in the future. Because the current system largely pays benefits through taxes paid by current workers, the financial health of the system is sensitive to the ratio of dependents to workers—sometimes called the age dependency ratio or support ratio. Trends and projections of dependency ratios, including the relationship between both older (years 65 and older) and younger (under age 20) dependents to the working-age population in the United States are considered in the first section of this demographic report. Next, the United States is compared to nine other nations, including the seven other members of the G8. In the final section, policy implications of the changing dependent-to-worker ratios are considered in the context of pay-as-you-go (paygo) social security systems.

Age Dependency Ratios

This section summarizes information on trends and projections over time in the ratio of working-age persons to persons in the dependent ages in the United States for the period 1950-2080.

Definitions

The age-dependency ratio relates the number of persons in "dependent" ages (defined here as persons under the age of 20 and over age 64) to those in "economically productive" ages (20-64 years) in the population. It addresses the question of how many dependents are being supported per 100 persons of working age. The age-dependency ratio is divided into old-age dependency (the ratio of persons 65 years and older to those in the working ages 20-64) and child dependency (the ratio of people under age 20 to those ages 20-64).

Trends

Based on data contained in the Annual Report (2006) of the Federal Old-Age and Survivors Insurance and Disability Insurance ("Social Security") Trust Funds, Figure 1 shows the estimated and projected trends in age-dependency ratios for the period 1950-2080 in the United States. Ratios for years 1950-2005 are historical estimates based on actual data ; years 2006-2080 are model-based projections that rely upon assumptions about future trends in mortality, fertility, and immigration. A detailed table with the underlying population data and age dependency ratios for years 1950-2080 is provided in Table A-1 . Data in this section and in Table A-1 reflect the Social Security actuaries' intermediate assumptions (i.e., their best guess) of future trends in the underlying assumptions. The impact of variability in the assumptions used for the projections is considered later in this report ( Figure 2 ).

As seen in Figure 1 , there were 72.5 dependents per 100 persons of working age in 1950; of these, 58.7 dependents were children while 13.8 were older persons. The total dependency ratio reached its height in 1965, just after the last of the Baby Boom generation was born. In 1965, there were 94.7 (of which 76.5 were children and 18.2 were older persons) dependents per 100 persons of working age. There have been divergent trends for the child and old-age dependency ratios in recent decades with the child ratio generally falling and that of older persons increasing. Children continue to out-number older persons in their contribution to the total dependency ratio in 2006 by a sizable margin: there are 45.9 child and 20.3 older dependents per 100 persons of working age.

Older Dependents

The old-age dependency ratio has generally been increasing since 1950. The baby-boom generation (persons born between 1946 and 1964) will accelerate the rate at which the old-age dependency ratio changes. Baby boomers will begin to attain age 65 beginning in 2011 (for those born in 1946) and continuing through 2029 (for those born in 1964). As highlighted in Figure 1 , the older age dependency ratio will quickly increase as a result of the aging of the baby-boom generation, from about 21.2 to 34.3 older dependents per 100 persons of working age between 2011 and 2029. Population aging, however, will continue to be one of the most important defining demographic characteristics of the U.S. population, even after the youngest of the baby-boom generation passes away. The number of older dependents per 100 persons of working age will continue to increase, albeit at a slower pace than will be experienced during the years in which the baby boomers retire. Based on the SSA Trustees' current assumptions, there will, for instance, be 42.1 older dependents per 100 workers in 2080.

These trends reflect forecasts of continuing improved survival at the older ages and continuing low fertility rates. Increasing rates of survival mean a greater number of older dependents (the numerator of the ratio), which in turn increases the old-age dependency ratio. Fewer (than current) births will mean fewer young dependents in the short-run, but will translate into fewer future workers in about two decades. At that time, the net effect will be that the old-age dependency ratio will be increasing (as the number of dependents will be increasing in the numerator) while the number of working age persons to support them will be falling (in the denominator). From the perspective of the Social Security program, the old-age dependency ratio is the most critical of the dependency measures as it relates the number of potential Social Security beneficiaries ($ outlays) to the number of projected payroll tax payers ($ income). Thus, the lower the old-age dependency ratio, the lower the dollars paid out versus received, and the better the finances of the Social Security program outlook.

Child Dependents

Referring again to Figure 1 and Table A-1 , the child dependency ratio increased from 58.7 to 76.5 child dependents per 100 working age adults between 1950 and 1965, largely reflecting the birth of the baby-boom generation. Since 1965, the child dependency ratio has experienced a mostly steady decline due to falling fertility rates in the United States. Nonetheless, in 2006, the number of child dependents is more than double the number of older dependents—45.9 and 20.3 per 100 working age adults, respectively.

The SSA Trustees' current projections assume that child dependency ratios will slowly decline through year 2080 but that the rate of decline will be very slow. Child dependency ratios will stay in the narrow range of 43.9 to 45.9 child dependents per 100 working age adults throughout this 75-year time span.

Note that, even with the pending retirement of the baby-boom generation, the number of child dependents has and will continue to be greater than the number of older dependents in each of the years of the time frame considered here.

Some Take-Away Messages

If the Social Security population estimates and projections for the 130-year period of 1950-2080 are correct, then the greatest demographic "burden"—when the number of dependents (children plus the elderly) relative to the working-age population—is already in the past, having reached its height in 1965 when there were 94.7 dependents per 100 persons of working age. The total number of dependents per 100 persons of working age has generally been decreasing since 1965 but is expected to reverse course beginning around year 2013. The change coincides with the retirement of some early cohorts of the baby-boom generation. The composition of the dependency ratio is changing. The number of children per worker has been falling since 1965; most of the anticipated increase in the dependency ratio in the coming decades reflects a growing proportion of older persons (ages 65 and older). These age-specific trends in the age dependency ratios are not, however, off-setting in terms of their federal budget implications. Programs carried out by the federal government focus much more heavily on assisting the elderly population. Based on estimates from the Congressional Budget Office (CBO), the federal government spent a little over one-third of its budget—about $615 billion—on transfer payments and services (with the Social Security and Medicare entitlement programs being the biggest expenditures) for people age 65 and older in FY2000. Federal spending on children was about $148 billion, or $175 billion if payments to the children's parents were included. State and local governments have historically provided substantial support for families with children through spending on elementary and secondary education and other programs. Nevertheless, because federal spending dwarfs state and local figures, total government spending for the average person 65 years or older is still much greater than for the average child. Age dependency ratios, while providing a glimpse at how the age structure of the population is changing, are nonetheless crude measures that do not take into consideration whether persons of working age are actually working and supporting the economy, nor whether dependents are truly economically dependent and receiving transfers from working-age persons. Furthermore, as noted by Friedland and Summer, "society's future is not determined solely by demographic changes. Focusing on the anticipated growth in population by age group is just too simplistic an approach. Rather, the future is shaped by the choices made—or not made—individually and collectively, bounded by the limits in resources and, in particular, knowledge. Knowledge is at the heart of gains in productivity, economic growth, and the advances in medical care, agriculture, communication, transportation, and the environment."

Variability of Future Projections

The ratios reported here are CRS compilations based on estimates and projections from the SSA. The information for years 1950 (the earliest available year) to 2005 are estimates that are based on actual data ; the information for years 2004-2080 are projections, which rely upon assumptions about future mortality, fertility, and immigration patterns.

To address the uncertainty that is inherent in all population projections, SSA constructs several sets of projections which are based on different combinations of assumptions. The data represented here uses the intermediate set of projections in the Trustees Report, which represents the Board's best estimate of the future course of the population. The Trustees produce two additional sets of projections, the "high-cost" and "low-cost" scenarios, which use differing assumptions about the future courses of fertility, mortality, and immigration. Figure 2 highlights the possible variation in the total dependency ratio through 2080 under these three different scenarios. While SSA's best guess of the total dependency ratio in year 2080 is 86.1 dependents per 100 persons of working age, the range of possible values varies from 83.1 to 94.5.

An International Comparison: Is the American Situation Unique?

Figure 3 presents statistics on the number of older persons supported per 100 persons of working age in 2002 in 10 countries. Eight of the countries are members of the G8, a consultative grouping of leading industrial democracies: Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States. In addition, China and India, the two most populous countries globally, are included to highlight that population aging is occurring even in nations that are less industrialized and have "younger" current age structures.

Of the 10 countries included in the comparison, Italy ranked first, with Japan close behind, in terms of the number of older persons being supported per 100 workers in 2002—29.6 and 29.5, respectively. Among the G8 countries, Canada and the United States were tied for last place at 20.8 older persons per 100 persons of working age—indicating that the Canadian and American "burdens" are less than those of the other G8 countries. Not coincidentally, the proportions of their population aged 65 and older—13% and 12% respectively in 2000—are also the lowest of the G8 nations. In India, with its young age structure, there were only 9.0 older persons per 100 persons of working age. The total age dependency ratio (not shown in graph) is, however, greatest for India among the 10 countries—there are 90.5 dependents (mostly children) per 100 persons of working age.

Figure 3 also highlights that population aging is a global phenomena—the number of older dependents per 100 persons of working age is projected to increase through 2025 in all 10 of the countries considered here. The projected increase in Japan, where the ratio will reach 51.1, is especially notable. Italy and Germany will each have over 40 older dependents per 100 persons of working age. Increases are also expected in both China and India. In fact, the old-age dependency ratio in 2025 in China will exceed the level observed in the United States, Canada, and Russia today.

Figure 4 shows the number of child dependents per 100 persons of working ages. India had the highest child dependency ratio in 2002 at 81.5. Of the G8 countries considered, the United States was the leader, largely reflecting the fact that the American fertility rate, while currently hovering around the replacement level, has not fallen as far as in the other G8 nations. For instance, the total fertility rate in Italy was 1.2 in 2002 compared to 2.1 in the United States in the same year. The estimates for India and China, and to a lesser extent the Russian Federation, are also affected by differential (higher) rates of infant and childhood mortality.

Unlike the increasing old-age dependency ratios highlighted in Figure 3 , the child dependency ratios are projected to fall through 2025 in most of the countries considered. The notable exception is the United States where it is projected that there will be 47.4 child dependents in 2025, as there had been in 2002.

In summary, population aging, which results primarily from declining fertility rates and increasing survival, is a global phenomenon. Today, the United States is the "youngest" of the industrialized G8 nations. While the proportion of the U.S. population that is aged 65 and older will continue to increase, aging in the United States is still projected to be considerably slower than in any of the other industrialized countries. In addition to reflecting the fact that the American fertility rate, which is currently hovering around the replacement level, has not fallen (nor is it projected to) as far as the other G8 nations, the "U.S. is leading the way in adapting to the changing balance ... by encouraging immigration." The SSA estimates that net legal immigration and net other immigration were about 675,000 persons and 400,000 persons, respectively, in 2005. For its future projections, SSA assumes the total level of net immigration (legal and other, combined) under the intermediate projection to be 1 million persons annually in the 2010s, 950,000 annually in the 2020s, and 900,000 annually in 2030 and each year thereafter through 2080. While these comparatively high levels of immigration differentiate the United States from the other G8 nations, they have a small effect on the median age of U.S. residents and on the total dependency ratio as immigrants are mostly young people who have children (and also higher fertility rates than the U.S.-born population). Immigration nudges the worker-elderly ratio a little higher, meaning that there are more people of working age per person age 65 or older. The more dramatic effect, however, is at the younger ages. Immigration after 2000 is projected to add about 15 million more children under age 18 than there would be without any post-2000 immigration. Continued immigration will lower the worker-child ratio and increase the child component of the dependency ratio.

Implications for a Paygo Social Insurance Program

What is Paygo?

Most Western industrialized nations, including the United States, have systems in place providing significant social security benefits, and virtually all of these plans originated with pay-as-you-go (paygo) or quasi-paygo funding schemes. In the United States, payroll or self-employment tax contributions by current workers (and their employers) are transferred to current beneficiaries. The majority of Social Security taxes paid by today's workers are not put into a special account to pay for their future benefits. Rather, they are used to pay benefits for persons receiving benefits today, just as the future benefits for today's workers will be paid by future generations of workers. In general, a low ratio of retirees to workers (the system's old age dependency ratio) and a high rate of productivity and real wages would permit a paygo social security system with high benefits or low contributions.

What Made Paygo an Attractive Option for Financing Social Security Systems?

Advantages of government-sponsored paygo schemes relative to fully funded systems include the following:

The entire working population can be covered relatively easily. The benefits can serve as social insurance against the (income) risks associated with old-age and disability. Benefits can be immediately vested and are fully portable, an important feature for a mobile work force. Administrative costs are usually very low.

Given these advantages, paygo systems looked very attractive in the immediate post-World War II years. Projections of labor force growth, coupled with forecasts of real wage growth, implied a potential total annual return near 5% for a fully mature paygo system. In contrast, the common view of a funded system involved investing contributions in government securities with a return of 1% or less. In the aftermath of the Great Depression, the market for equities seemed far too risky, and many countries lacked private bond markets. Furthermore, most countries instituting a new pension system were unwilling to delay initial benefit payments for several decades, as would have been required under a funded system. There was a desire to address the immediate problem of high poverty among the elderly, and most countries provided benefits to an older generation of workers which had not contributed fully to the system. Also, to many at that time, a high rate of population growth (and subsequent work force growth) seemed inevitable, in which case pay-as-you-go seemed a good way to finance an old age pension program.

The Current Outlook for Paygo, Given Demographics and Other Factors

The current outlook is much different. Birth rates have fallen considerably while the life expectancy at the older ages has increased significantly, resulting in less favorable old-age dependency ratios (as shown in Figures 1 and 2 ). While the old-age dependency ratio had already been increasing since 1950, the upcoming retirement of the baby-boom generation will accelerate the rate at which it grows. However, even after the youngest of the baby-boom generation has passed away, the number of older dependents per 100 persons of working age will still continue to increase, albeit at a slower pace than will be experienced during the years in which the baby boomers retire.

Concurrent with these demographic trends, the Congressional Budget Office (CBO) projects that federal spending for Social Security, adjusted for inflation, will rise substantially—from $483 billion in 2003 to $2.5 trillion in 2075. The projected rise in Social Security spending is due, in part, to the demographics of an aging society; CBO estimates that approximately 55% of the higher spending is due to the expected increase in the number of beneficiaries, as the number of new claimants grows and as life expectancy rises. The remaining 45% of the rise is due to a projected increase in the real value of Social Security benefit checks. Specifically, they note that, under rules put into effect in 1979, benefits of newly eligible recipients are based on a formula and earnings records that are adjusted for wage growth. Those adjustments, referred to as wage indexing, are designed to keep the ratio of initial benefits to pre-retirement earnings—that is, replacement rates—approximately the same from one generation of new recipients to the next. Wages tend to rise along with productivity in the economy, at a faster pace than prices and, over the long run, a system pegged to wage growth will gradually afford greater purchasing power.

As both CBO and the Government Accountability Office (GAO) are warning, current spending policies are likely to be unsustainable. The policy implication is that, unless there are large offsetting productivity gains in the U.S. economy, contribution rates by current workers (e.g., tax rates) must markedly rise or benefit levels must fall under Social Security's paygo system. Alternatively, the structure of the underlying paygo system could be modified such that part or all of the scheme is fully funded. This, however, raises the same issues that caused most countries to originally select paygo systems: reduction of (investment) risk and the need to pay benefits for the current generation of beneficiaries.

Appendix.