Tuesday, January 4, 2005

Republicans and lobbyists close to President George W. Bush have reported that the White House will propose changing the formula for establishing initial Social Security benefit levels in order to cut guaranteed expenditures on future retirees, according to today’s Washington Post. The Social Security Administration would no longer use the increase in wages over a worker’s lifetime to calculate retirees’ first-year benefits but would use inflation rates instead. The new “price indexing” formula will reduce individual benefits and overall Social Security outlays because the inflation rate typically is much lower than the rise in wages. The full impact of the change will be felt in the middle of the century.

The Bush Administration proposal, which will be offered to Congress in February or March 2005, is part of an overall Social Security reform package that also would create “personal investment accounts” into which individual taxpayers could divert part of their payroll taxes. The White House believes that the shortfall in benefits created by the adoption of price indexing would be made up by capital gains from the stocks and bonds held by individual taxpayers in their personal investment accounts.

The move is akin to the private sector’s migration from defined benefit retirement plans to defined contribution benefit plans such as 401(k)s as almost half of a worker’s benefits will not be guaranteed by the year 2075. President Bush will support the move to price indexing for calculating initial benefits by pointing out that it was the approach recommended by his 2001 Commission to Strengthen Social Security.

Benefits currently are calculated by averaging a worker’s earnings in their 35 highest-paid years and adjusting earnings to factor in cost of living standards at the worker’s retirement age. Under the Bush proposal, rather than adjusting benefits on the basis of earnings growth, the calculation would be based on the increase in the consumer price index over those years.

The implementation of “price indexing” would cut future Social Security costs by trillions of dollars. However, the cuts in guaranteed benefits for middle-class and some high-income workers would be substantial: 9.9% for workers retiring in 2022, over 25% for workers retiring in 2042, and 46% for workers retiring in 2075.

Opponents of the price-indexing proposal point out that inflation-based calculations of benefits, by linking benefits to prices but not wage levels, would cut retirees out from future increases in living standards since it is wages and not prices that determine standards of living. While American Association of Retired Persons (AARP) Policy Director John Rother concedes that many of the arguments of opponents are valid, price indexing is inevitable and must be viewed in the context of President Bush’s total reform package.

Rother points out that Social Security benefits, which currently equal 42 percent of the earnings of an average worker retiring at age 65, would be reduced to 20% of pre-retirement earnings for future retirees, thus potentially freezing retirees into today’s standard of living. However, Rother says that price indexing has to be linked to Bush’s private investment accounts as income from the accounts give retirees the chance to make up the shortfalls.