According to the Social Security Trustees, the Social Security Trust Fund will be able to pay full benefits until 2037, and incoming payroll taxes will be sufficient to pay about 78 percent of benefits thereafter. Some are using this modest gap in long-term funding as a pretext to justify proposals for large cuts in Social Security benefits destined to reduce the federal deficit. One option to cut benefits, which was proposed by former President Bush and rejected but is again being considered, is to change the formula for determining initial Social Security benefits from one based on wages to one based on prices.
Price indexing Social Security is a profound transformation of the current program from one based upon workers' contributions during their working lives to a flat benefit provided to all workers, irrespective of their contributions. Over time, this benefit would drop to welfare-like levels. This would transform the current universal social insurance program into a means-tested welfare program, eventually undermining the broad public support that Social Security has enjoyed for 75 years.
Social Security's Current-Law Wage-Indexing
Under current law, initial Social Security benefits are based on a worker's earnings indexed to reflect the growth in wages. This ensures that each generation receives Social Security benefits that reflect the growing standard of living they helped create during their working years.
In addition, Social Security is currently designed to ensure that each new group of retirees will receive a benefit that replaces the same proportion of past wages as the previous group of retirees. This "replacement rate," due to Social Security's progressive benefit formula, varies by income. Low-wage earners receive benefits which replace a higher proportion of their pre-retirement earnings than do median- or high-wage earners.
Historically, wages have risen more quickly than prices, so indexing a retiree's initial benefit amount to reflect wage inflation provides a retirement benefit that more accurately represents the value of those wages in the year they were earned. Wage-indexing allows the value of Social Security benefits in replacing lost wages to stay steady from one generation to the next.
Price indexing would dramatically change how initial benefits are calculated. Low-wage workers would continue to have their benefits determined by the current wage-indexing formula, allowing them to continue receiving an initial benefit that reflects the value of their wages in the year they were earned. Medium-wage workers' initial benefits would be calculated using a new formula that would blend wage and price indexing, reducing the value of their benefits and beginning to erode the link between their contributions and benefits. Initial benefits for higher-wage workers would be calculated using a formula that is fully indexed to prices, completely severing the link between benefits and earnings and dramatically cutting their benefits.
- Price indexing would cut Social Security benefits dramatically. Despite arguments that price indexing only "slows the growth" in Social Security benefits, the policy would result in real benefit cuts. It would affect workers making more than about $24,000 a year - or over 70 percent of the workforce. Because the mechanics of this change are complicated, the reductions stemming from it would be extremely difficult for people to understand or anticipate.
- How big would the reductions be? Although they would start small, the benefit cuts resulting from this change would grow substantially over time. It has been estimated that if Social Security benefits had been figured using this formula starting in 1950, current benefits would only be half as large as they are now. As an example, today's middle income retiree who applied for benefits at age 62 would receive a monthly benefit of only about $583 rather than today's benefit of $1,167.
- Social Security replacement rates would be drastically reduced. Such massive cuts in benefits would reduce the percentage of pre-retirement income replaced by Social Security benefits. The reduction in replacement rates would continue indefinitely, and the purchasing power of retirees would decline permanently.
- The link between Social Security benefits and earnings would be eliminated. P rice indexing would ultimately result in retirees at all income levels receiving approximately the same minimal Social Security benefit, regardless of having paid very different amounts in payroll taxes during their working lives. The very nature of Social Security as a contributory social insurance program that is fair across generations would be destroyed.
Over time, price indexing Social Security would lead to massive reductions in benefits. Despite the impression left by some, the average Social Security retirement benefit today is modest - only $13,800 per year overall with an average of only $11,800 per year for women. Cutting these benefits, no matter how it is accomplished, should not be the first or last place Congress looks for budget savings.
Government Relations and Policy, August 2010