Bernard Wasow and Martha Paskoff Welsh demonstrate how price-indexing (as proposed by the President's Commission to Strengthen Social Security) would negatively affect standards of living for retirees. They calculate how benefits today would be altered if price indexing had been introduced in past years. For example, if price indexing had been instituted beginning in 1983, they find a retiree claiming benefits at 65 today would see their annual benefit reduced from the current level of $13,896 to $10,884—a reduction of 21.6 percent. Even with the addition of private accounts, they find future benefits would be reduced under the Commission's Model as compared to guaranteed Social Security benefits. Read it below or download in PDF format.

INTRODUCTION

President George W. Bush is expected to propose a major change in the way that guaranteed Social Security benefits are set-a change that will result in deeper and deeper reductions in benefits over time. The proposal was recommended in 2001 by the President's Commission to Strengthen Social Security, and the media have reported in recent weeks that the president is likely to endorse it. Under the plan, the younger you are, the more severe the cut would be in your guaranteed Social Security benefits. By 2042, for example, an average wage earner who retired in that year would receive a benefit that was 26 percent below what it would be under current law, according to the Center on Budget and Policy Priorities; an average wage earner who retired in 2075 would receive an initial benefit that was 46 percent lower. [1] These reductions would be a result of ending the policy, first implemented in 1974, of linking Social Security benefits to past wage growth.

Currently, the Social Security program takes into account that, from one generation to the next, living standards for everyone rise because workers become more productive. When workers retire, Social Security recognizes the value of their contribution to the improved living standards of succeeding generations by setting benefit levels that keep up with past wage growth. In this sense, the adjustment also reflects the legacies past workers leave to following generations, such as the labor that goes into creating inventions and even building roads, factories, homes, and educational institutions.

Under the Bush commission's proposal, however, benefits would become tied only to the inflation of prices (a practice known as "price indexing"). Prices generally increase more slowly than wages. Wage growth in excess of price inflation is what enables living standards to improve over time. Those better living standards derive directly from the labor of workers. By ending the practice of linking Social Security benefits to improvements in living standards, the president's commission would be telling future workers that they will not be able to enjoy the fruits of their own labor. Instead, their living standards in retirement would be tied to living standards back when price indexing was originally introduced.

A DIFFERENT WORLD

Suppose the commission's price-indexing proposal had come into effect at the beginning of the career of someone who began working in 1959 and retired in 2003 at the age of sixty-five. The proposal would, in essence, transport sixty-five-year-old retirees back to the economy that existed at the end of the Eisenhower administration, assuring them of only the purchasing power that a retiree had at that time. Today, American households broadly own and benefit from all kinds of products and services that were considered luxuries, or were nonexistent, forty-six years ago: color television, reliable and effective air conditioning and heating systems, microwave ovens, home computers, and a myriad of vastly improved prescription drugs and medical procedures. There are many, many other examples. Not only invention but rising purchasing power has converted such 1959 luxuries as color television and automobile air conditioning into necessities today.

Here is what that would mean in dollars and cents: a sixty-five-year-old worker retiring in 2003 who earned an average wage throughout the course of his or her career would have received a guaranteed monthly benefit of just $701, instead of the payment of $1,158 that he or she would have received under the current system. The commission's proposed approach would leave the worker with benefits totaling just $8,412 (in 2003 dollars) for the year-5 percent below the poverty threshold and 40 percent below the $13,896 that today's system would have provided (see Table 1). [2]

Table 1. Benefit Reductions if Price-Indexing Had Been in Effect since 1959

Suppose, instead, that price indexing had only been introduced in 1983, which was the last time major changes were made to the way Social Security benefits are calculated. What would benefits for today's retirees look like in that case? Table 2 below shows the extent to which guaranteed benefits would have been reduced for individuals retiring in 2003 if the commission's price-indexing proposal had been introduced in 1983. [3]

Table 2. Benefit Reductions if Price-Indexing Had Been in Effect 1983

NO QUICK FIX FROM PRIVATE ACCOUNTS

Many people associate the proposal to switch from wage indexing to price indexing with the proposal to divert some Social Security revenues to private investment accounts. But it is important to realize that the reductions in benefits from a switch to price indexing would apply to everyone, even those who chose to stick to the traditional Social Security system. For workers who did opt to open private accounts, the proposal of the president's commission would reduce guaranteed benefits even more. That is because the money going into private accounts (with accrued interest) would be deducted from the guaranteed benefits of the worker who opened the private account.

Let us take as an example a married couple in which both individuals earned medium wages and who retire in 2042. [4] With price indexation, the guaranteed income for the individual would be $1,098, 26 percent less than the $1,478 guaranteed under today's system. If they decided to open private accounts and invest them conservatively in Treasury Bonds, each would lose an additional 21 percent of guaranteed benefits, receiving a monthly check from Social Security of only $782, not much more than half of what today's system would guarantee.

How about the returns from the private account? Adding in the value of the Treasury bonds raises total benefits to $1,175, a little better than the basic $1,098 guarantee.

If the couple were willing to take on the risks of the stock market, the Social Security actuaries predict that they should each expect to take home retirement benefits of $1,437 per month. Although the assumptions in these forecasts about the rate of return to stocks are much more optimistic than their assumptions about economic growth warrant, the Social Security Actuaries' forecast for average benefits still come in lower than the $1,478 guaranteed under today's Social Security system. Many workers will do worse than the expected return on stocks, some much worse. Those who are unlucky or unskillful in investing will have only the whittled down guarantee of $782 per month to fall back on.

The addition of private accounts adds enormous risk and still leaves expected benefits below those of today's Social Security system.

CONCLUSION

The difference between today's policy of setting Social Security benefits based on each worker's past wages, adjusted for increases in living standards, versus the commission's price-indexing proposal can seem mind-numbingly complicated. But it is a critically important distinction not just from a dollars and cents standpoint, but also as a matter of principle. Social Security can be credited with significantly reducing the poverty rate among the elderly-from more than 35 percent before 1960 to just 10 percent today. Proposals such as the one endorsed by the commission to radically change the way the system works would fundamentally alter the features that have made the program so successful.

NOTES

[1] Robert Greenstein, "So-Called 'Price Indexing' Proposal Would Result in Deep Reductions over Time in Social Security Benefits," Center on Budget and Policy Priorities, January 28, 2005, available online at http://www.cbpp.org/12-17-04socsec.htm.

[2] We assume a present-day average monthly benefit of $1,158 in calculating how much less beneficiaries today would receive if price indexing had been implemented. This is the starting benefit for the average income earner who retired at the normal retirement age (assume sixty-five years old) and was eligible for full benefits in 2003. This amount is higher than the average monthly benefit for all recipients or even all average income earners because it does not include those people who choose to retire early and therefore receive discounted benefits. In addition, this starting average monthly benefit does not represent new retirees with fewer than 35 years of wage history, whose monthly benefits would also lower the average. Social Security Administration, "Fast Facts and Figures about Social Security," June 2003, Hypothetical Benefit Amounts Table, available online at http://www.ssa.gov/policy/docs/chartbooks/fast_facts/2003/ff2003.html#agedpop

[3] Wage index data are from National Average Wage Index, Social Security Administration, October 19, 2004, available online at http://www.ssa.gov/OACT/COLA/awiseries.html; CPI-U datum from 1958 is from the MIT Office of the Provost, Institutional Research, August 3, 2004, available online at http://web.mit.edu/ir/cpi/cpi-u.html; CPI-U data from 1959-1977 and revised CPI-U-RS data from 1978-2003 are from Council of Economic Advisors, Economic Report of the President, 2004, February 2004, table B-60, available online at http://www.gpoaccess.gov/eop/tables04.html.

[4] These examples are taken from The President's Commission to Strengthen Social Security. Social Security Administration, "Estimates of Financial Effects for Three Models Developed by the President's Commission to Strengthen Social Security," January 29, 2002, Full Annuitization of Personal Account Assets at Retirement With a CPI-Indexed Life Annuity on a Joint and 2/3 Survivor Basis Table: Plan 2, 2-Earner Couple, available online at http://www.ssa.gov/OACT/solvency/tables_20020131/Plan%202-2e.html.