Because the proposals are complicated and are often couched in rhetoric that is confusing and even misleading, this brief provides some basic information about them to clarify what is at stake:

The newly proposed cuts in guaranteed benefits would not reduce the huge amount of federal debt required to finance the previously announced plans for private accounts. Paying for the new accounts would still require $4.9 trillion in additional federal borrowing over the first 20 years of the plan, while depleting Social Security's trust funds more than 10 years sooner than would be the case without private accounts. The proposed benefit reductions would not change those projections.

Middle-class workers would receive substantially less from Social Security. A 25-year-old worker who earns the average wage over the course of his or her career—about $36,500—would receive a reduction in Social Security benefits of $3,523 a year (in today's dollars, adjusted for inflation) upon retirement in 2045. That's 16 percent lower than would be the case under current law. An average worker retiring in 2075 would receive $7,629 less—a 28 percent reduction.

The cut in guaranteed benefits to middle-class workers who elect to open private accounts would be even more severe. An average worker retiring in 2075 who elected to invest 4 percentage points of his or her payroll taxes in investment accounts would receive a guaranteed benefit of just $7,301 (in today's dollars). That compares to $27,344 under current law, and $19,715 for those who do not open accounts. Individuals with accounts would get back more than $19,715 only if their investments earned more than 3 percent a year above the inflation rate. As a February Goldman Sachs report stated, "In essence, the 3 percent real offset represents a loan from the government to the account holder to fund the personal savings account. This is not an attractive proposition."

Workers who earn more than the average income would face even deeper reductions in guaranteed benefits. Someone who earns 60 percent above the average wage—about $58,000 today—would face a 25 percent cut upon retirement in 2045 and a 42 percent reduction in 2075. For a worker at that income level who opens a private account with a maximum contribution, the guaranteed benefit from Social Security would be reduced by 87 percent—to just $3,750 in today's dollars. The higher your income, and the younger you are, the deeper the cut.

Source: Jason Furman, Robert Greenstein, and Gene Sperling, "Why Progressive Price Indexing Could Lead to the Unraveling of Social Security," Center on Budget and Policy Priorities, April 26, 2005. Figures are projected annual Social Security benefits in 2005 dollars for beneficiaries retiring in specified year, not including the value of private accounts.

Far less severe cuts in guaranteed benefits, without the added costs of private accounts, could eliminate Social Security's projected shortfall decades from now. For example, a plan proposed by economists Peter Diamond on MIT and Peter Orszag of the Brookings Institution would restore Social Security's long-term fiscal balance indefinitely while imposing benefit reductions roughly half the size of those the president endorsed. Adding revenue to the system by, for example, raising the $90,000 ceiling on income subject to the payroll tax or earmarking future estate taxes to Social Security can significantly limit the need for such painful benefit cuts.

Despite claims about protecting future retirees from poverty, the benefit reductions would leave far greater numbers of Americans closer to the poverty level or below it. More than half of households between the ages of 65 and 75 are living on less than $30,000 a year, and more than half of households over 75 are living on less than $20,000. Social Security provides more than half the income of nearly 40 percent of households aged 65 to 75; among households over 75 years old, 60 percent get the majority of their income from Social Security. (See AARP, The State of 50+ America.) Most retirees in these categories would have significantly lower benefits today if the proposed system had been in effect in the past.

The rationale for the benefit reductions breaks a promise made years ago to working Americans. Under the president's proposal, the level of benefits that middle- and upper-income workers receive upon their retirement would become tied to the inflation of prices over their working years rather than past wage growth. Prices generally increase more slowly than wages, and 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 eroding the practice of linking Social Security benefits to improvements in living standards, the "price-indexing" proposal conveys to 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. Ultimately by 2100, as Jason Furman of the Center on Budget and Policy Priorities has pointed out, the majority of workers would get an identical baseline Social Security benefit regardless of their previous earnings and payroll tax contributions.

The proposal creates perverse incentives. Under price indexing, the faster real wage growth is in the future, the larger Social Security benefit cuts relative to current law will be. For example, Furman calculates that under the Social Security Trustees' assumptions of 1.1 percent annual real wage growth, an average-wage earner retiring in 2075 would get a 28 percent benefit reduction; but if real wages were to grow at 1.6 percent, the same worker would face a 35 percent benefit cut. In essence, the change would punish future retirees for stronger economic performance that they contribute to during their working careers. In addition, while stronger future economic growth now means that full benefits can be paid with no changes, under price indexing stronger economic growth would just lock in ever deeper benefit reductions.

CONCLUSION

If no changes are made to Social Security, it will be able to continue paying currently promised benefits in full until the year 2041 (according to projections of the system's Trustees) or 2052 (according to the Congressional Budget Office). After those dates, promised benefits would have to be reduced between 20 percent and 30 percent. Avoiding that shortfall down the road is an important challenge that requires serious attention. But the proposed changes would unnecessarily add trillions of dollars of new federal debt while imposing far deeper benefit reductions than necessary. In the process, the nation's most successful government program would be fundamentally transformed and weakened.

SOURCES

Stephen C. Goss to Bob Pozen, "Estimated Financial Effects of a Comprehensive Social Security Reform Proposal Including Progressive Price Indexing," Memorandum, 10 February, 2005, Office of the Chief Actuary, Social Security Administration.

Jason Furman, Robert Greenstein, and Gene Sperling, "Why Progressive Price Indexing Could Lead to the Unraveling of Social Security," Center on Budget and Policy Priorities, April 26, 2005.

Jason Furman, "An Analysis of Using 'Progressive Price Indexing' To Set Social Security Benefits," Center on Budget and Policy Priorities, March 21, 2005.

Peter R. Orszag, "Social Security Reform," Testimony before the Senate Committee on Finance, April 26, 2005.

Patrick Purcell, "Progressive Price Indexing" of Social Security Benefits," Congressional Research Service, April 22, 2005.

Alicia Munnell and Maurice Soto, "What is Progressive Price Indexing?" Center for Retirement Research, Boston College, April 2005.

The State of 50+ America 2005, AARP, January 2005.