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Tags: benefit cuts, careful examination, cato institute, cbpp, fidelity, furman, heritage foundation, lindsey graham, michael tanner, political risk, president bush, private account, private accounts, proponents, robert bennett, robert greenstein, robert pozen, social security, social security benefit, social security plans,Pages: 6
Language: english
Created: Tue Apr 26 10:05:14 2005
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820 First Street, NE, Suite 510, Washington, DC 20002
Tel: 202-408-1080 Fax: 202-408-1056 center@cbpp.org www.cbpp.org
April 26, 2005
WHY PROGRESSIVE PRICE INDEXING
COULD LEAD TO THE UNRAVELING OF SOCIAL SECURITY
by Jason Furman, Robert Greenstein, and Gene Sperling1
Overview
"Progressive price indexing," a change in the Social Security benefit structure proposed
by former Fidelity executive Robert Pozen, is becoming increasingly prominent in discussions of
Social Security. Senators such as Lindsey Graham and Robert Bennett have indicated they
intend to include it in Social Security plans they are developing. President Bush has praised the
proposal. And various private account proponents such as Michael Tanner of the Cato Institute
and David John of the Heritage Foundation have spoken warmly about it.
Progressive price indexing is presented as a way to protect low-income workers from
Social Security benefit cuts and to moderate the effect on middle-income workers, while
reducing benefits most for high-income workers. Careful examination suggests, however, that
progressive price indexing, if combined with private accounts, would pose serious risks to all
workers, because it could put Social Security on a path that would severely weaken support for
the program over time.
It would be desirable to make the Social Security benefit structure somewhat more
progressive although doing so creates some political risk for Social Security. But when
progressive price indexing is coupled with private accounts, the political risk escalates very
substantially.
· Progressive price indexing represents a large benefit cut; it would close 73 percent
of Social Security's 75-year financing gap by itself. Plans that include this
proposal rely heavily on benefit reductions to restore solvency, rather than on a
balanced mix of benefit reductions and revenue increases, as was done in 1983.
As a result, even though the largest benefit reductions under progressive price
indexing would fall on those with annual earnings at or above the Social Security
payroll tax cap (now $90,000 a year), workers who earn much more modest
wages would face quite significant benefit cuts. A medium earner (one who earns
$36,000 today) retiring in 2055 would face a 21 percent reduction (relative to the
current benefit structure) in his or her Social Security benefits. A worker who
earned 60 percent above the average wage -- about $59,000 today -- would face
a 31 percent cut.2 (These figures are based on the Social Security actuaries'
analysis of the progressive price indexing proposal.)
1
Gene Sperling is a Senior Fellow at the Center for American Progress. Jason Furman is a non-resident Senior
Fellow, and Robert Greenstein is Executive Director, of the Center on Budget and Policy Priorities.
2
For further analyses of progressive price indexing, see Jason Furman, "An Analysis of Using "Progressive Price
Indexing" to Set Social Security Benefits," Center on Budget and Policy Priorities, March 21, 2005.
F:\media\michelle\POSTINGS\4-26-05socsec.doc
Combined Effect of Progressive Price Indexing
and President's Private Accounts on Defined
Social Security Benefits
(For Worker Retiring in 2055 at Age 65; Figures in 2005 $)
$35,000
Current Benefit Structure
Progressive Price Indexing + $29,300
$30,000
Administration's Private Accounts
$25,000
$22,100
$20,000
$15,000
$10,000 $7,510
$3,750
$5,000
$0
Defined Benefit for Defined Benefit for
"Medium" Earner "High" Earner
(Currently Earns $36,000) (Currently Earns $59,000)
Source: CBPP Calculations
· Under private accounts like those the President has proposed, the cost of the
private accounts is offset by reducing substantially the Social Security benefits of
those who elect the accounts. If progressive price indexing is combined with
private accounts of this nature, Social Security benefits will be lowered twice --
once due to the indexing changes, and a second time to pay for the private
accounts. As this analysis explains, the result would be that millions of middle-
income workers would receive little or no Social Security benefits in retirement.
They would be left largely with only their private account.
· For example, under progressive price indexing and the private accounts that
President Bush has proposed, the defined Social Security benefit would be
reduced by 66 percent -- from $22,100 a year to $7,510, in 2005 dollars -- for a
medium earner who retires in 2055. For a worker who earns 60 percent above the
average wage, the reduction in Social Security benefits would be 87 percent --
from $29,300 a year to $3,750 (in 2005 dollars).
· Furthermore, these figures reflect Social Security benefits before Medicare
premiums are subtracted. (Medicare premiums are collected by being subtracted
from Social Security checks.) Since Medicare premiums grow at the rate of
health care costs, which is faster than either prices or wages, they will consume a
steadily increasing share of Social Security benefits over time. For many middle-
income workers, Medicare premiums would consume most or all of the very
small monthly Social Security benefit that would remain under the combination of
progressive price indexing and "carve-out" private accounts. Social Security
checks for millions of ordinary American workers thus would be close to or at
zero.
2
· If the occurred, the stage would be set for advocacy campaigns to be mounted
calling for private accounts to be expanded and to replace much or all of what
remained of Social Security. After all, workers would appear to have placed 8.4
percent of their wages in Social Security but to be receiving little or nothing in
return. The miniscule Social Security benefits many workers would receive under
the combination of progressive indexing and private accounts would almost surely
be seized upon by some on the political right to argue that Social Security had
become a terrible deal for American workers and that workers would benefit
greatly from converting much or all of what remained of Social Security to
private accounts.
· Stated another way, the combination of progressive price indexing and carve-out
private accounts would likely lead millions of Americans to undervalue Social
Security (and to overvalue their private accounts). Their private account might
lose money for them -- for many workers, the accounts might earn less than the
amount that their Social Security benefits would be reduced to offset the cost of
the accounts. But people nevertheless could appear to be getting more for the
four percent of their wages placed in their accounts than for the 8.4 percent that
went to Social Security (especially if they never became disabled and did not need
Social Security disability benefits).
Progressive price indexing also presents one other serious problem: it is unsound
economics. It cuts Social Security benefits (relative to the current benefit structure) by the
degree to which wages outpace inflation. As a result, the more that real wages grow, the deeper
the reduction in Social Security benefits would be. If the economy performed better in future
decades than is currently forecast, Social Security benefit cuts would be larger, even though the
stronger economic growth would cause the Social Security shortfall to become smaller. The
Congressional Research Service recently took note of this serious design flaw in the proposal in
an analysis of progressive price indexing, in which CRS stated: "Thus, somewhat paradoxically,
if real wages rise faster than projected, price indexing [either full price-indexing or progressive
price-indexing] would result in deeper benefit cuts, even as Social Security's unfunded 75
liability would be shrinking."3
Combining Progressive Price Indexing with Carve-out Private Accounts
Private accounts carved out of Social Security, as proposed by President Bush and a
number of Members of Congress, would be financed by additional benefit reductions in Social
Security for those who elect the private accounts. If progressive price indexing were included in
a Social Security plan alongside carve-out private accounts, Social Security benefits would be
cut twice for workers electing the accounts (other than people in the bottom 30 percent of the
wage distribution, who would not be affected by progressive price indexing).
The combined effect of these two benefit reductions would be dramatic, and not just for
high-income workers. Tables 1 and 2 show the level of Social Security benefits under: 1) the
current benefit structure; 2) progressive price indexing; and 3) progressive price indexing
combined with carve-out private accounts, structured as President Bush has proposed. Under
3
"Progressive Price Indexing" of Social Security Benefits, Congressional Research Service, April 22, 2005.
3
such accounts, for each $1,000 in payroll tax contributions that a worker shifted from Social
Security to a private account, the worker's Social Security benefits is reduced by $1,000 plus an
interest rate equal to 3 percent above inflation.
Table 1 shows the effects on workers who are 15 years old today and retire at age 65 in
2055. As the table shows, with progressive price indexing and carve-out accounts, Social
Security's defined benefit would drop dramatically not just for earners at very high income
levels, but for everyone except low earners.
· By 2055, Social Security defined benefits for medium earners -- those roughly in
the middle of earnings scale -- would drop 66 percent, or two thirds, compared to
the current benefit structure. (A medium earner in 2005 makes $36,000.) The
worker also would have a private account that would be subject to market risk.
· In addition, the group whom the Social Security actuaries label "high earners" --
workers whose average earnings are 60 percent above those of the medium
earner, or $59,000 today -- would face a Social Security defined benefit cut of 87
percent in 2055.
Table 1
Annual Social Security Benefit For Workers Retiring in 2055
(Benefits in 2005 dollars, does not include the value of private accounts)
With With Progressive
Current-
Progressive Price Indexing and
law Percentage Change
Price Benefit Offsets for
Formula
Indexing 4% Accounts
Low earner 13,413 13,413 8,906 -34%
Medium earner 22,097 17,545 7,513 -66%
High earner 29,296 20,214 3,750 -87%
Maximum earner 35,751 22,666 2,717 -92%
Source: Calculations based on Social Security Administration, Office of the Chief Actuary, "Estimated Financial Effects of a
Comprehensive Social Security Reform Proposal Including Progressive Price Indexing -- INFORMATION," February 10, 2005
and "Preliminary Estimated Financial Effects of a Proposal to Phase In Personal Accounts INFORMATION," February 3,
2005. Note that the 4% accounts are assumed to have a maximum contribution of $1,000 in 2009, growing by $100 per year plus
wage inflation, along the lines proposed by the President.
After Medicare Premiums Are Subtracted, Many Retirees
Would Receive No Social Security Benefit at All
Moreover, many of these individuals would receive no Social Security check at all.
Medicare premiums are collected by being subtracted from Social Security benefits; the Social
Security checks sent out each month equal a beneficiary's Social Security benefit minus his or
her Medicare premiums. Medicare premiums rise at the same rate as health care costs, which is
to say, considerably faster than wages or the general inflation rate. As a result, with each passing
year, Medicare premiums consume a larger proportion of Social Security benefits.
· The figures just cited -- that by 2055, the combination of progressive price
indexing and the Administration's private accounts would eliminate 66 percent of
the Social Security benefit for median earners, and 87 percent for so-called "high"
earners -- reflect the Social Security benefits that would remain before Medicare
premiums are taken into account.
4
· It is from these greatly reduced benefit amounts that the premiums for Medicare
physicians' coverage (Medicare Part B) and the prescription drug benefit
(Medicare Part D) would be subtracted. The Social Security check that
beneficiaries received would be what was left. For millions of workers, the
amount of the monthly Social Security check would be at or near zero.
The crunch would become even more severe after 2055. By 2075, as Table 2 shows, the
combined effect of progressive price indexing and the President's private accounts would be to
reduce Social Security defined benefits by 73 percent for median earners and 97 percent for the
so-called "high earners," even before the Medicare premiums are taken into account.
Table 2
Annual Social Security Benefit For Workers Retiring in 2075
(Benefits in 2005 dollars, does not include the value of private accounts)
With Progressive
With
Current-law Price Indexing and
Progressive Percentage Change
Formula Benefit Offsets for
Price Indexing
4% Accounts
Low earner $16,599 $16,599 $11,022 -34%
Medium earner 27,344 19,715 7,301 -73%
High earner 36,254 21,100 1,233 -97%
Maximum earner 44,236 22,428 0 -100%
Source: Same as Table 1.
In other words, this approach ultimately would decimate traditional Social Security
benefits for most workers. As a result, it would raise serious questions about whether the Social
Security system would remain politically viable. With private accounts being financed through
reductions in Social Security benefits rather than in the private-account balances, this approach
would make it appear as though most workers were contributing 8.4 percent of their wages to
Social Security and getting little or nothing back. Workers would appear to be getting much
more back for the four percent of wages they placed in their private accounts.
Of course, the difference would reflect, in part, the fact that the costs of the private
accounts were being recouped through reductions in Social Security benefits rather than in the
account balances. (The reductions could be made directly in the account balances, but most
private-account proponents do not favor that because the accounts would then appear less
attractive.) The difference between Social Security pay-outs and pay-outs from private accounts
also would reflect the fact that a portion of Social Security payroll taxes go for disability and
survivors insurance, for raising the benefits of retirees who have worked at low wages, and, most
importantly, to cover the "legacy debt" that Social Security inherited as a result of the decision
made when the program started 65 years ago to cover people who were retiring at that time and
had paid little or nothing into the system because Social Security wasn't yet in existence during
most of their work careers. (See the box on page 6 for a further discussion of these issues.)
It is unlikely that a system under which Social Security appeared to be such an abysmal
deal when compared to private accounts would be politically sustainable over time.
5
Are Private Account Plans Designed to Devalue Social Security? *
Social Security is a compact among all Americans designed to ensure a modicum of economic
dignity no matter what life may bring. Much of the value of Social Security lies in its role as insurance
against the threat to economic dignity that can come through disability, the early death of a provider,
poverty, or living to a very old age and exhausting one's savings. One-third of Social Security benefits
now go to survivors or workers who have become disabled and their dependents.
Advocates of replacing part of Social Security with private accounts often paint a distorted
picture of Social Security's value by describing it only in terms of its "return on investment." No one
would think it made sense to tell parents who had purchased auto and fire insurance that they had been
terrible investors and had robbed their children of their inheritance because, with no accidents or fires,
they had a negative return on their insurance premiums. That would be a distorted frame for assessing the
value of insurance; you hope you never need it, but insurance can make all the difference for a family if
life takes a difficult and unexpected turn.
Many private-accounts plans are designed in such a way that Social Security recipients would be
likely to undervalue the benefits of Social Security and to overvalue their private account. Most "carve-
out" private-account plans, such as the plan the President has outlined, are designed in a way that is likely
to lead people to think the accounts are a better deal than they are, because the plans obscure the fact that
the accounts have a large cost that must be incurred. The White House purposely designed its proposal so
that the "offset" (i.e., the reduction in benefits needed to pay for the accounts) would not be taken out of
the accounts themselves, but out of Social Security checks instead. A more transparent design, under
which the Social Security Trust Fund would be paid back directly from the account balances, rather than
by cutting Social Security benefits, would make the accounts look much more modest to beneficiaries and
traditional Social Security benefits look more robust.
Moreover, most private-account proposals would make Social Security appear to be a worse deal
relative to private accounts than would be the case, for another reason as well. A substantial share of the
payroll taxes dedicated to Social Security are used to finance the cost of survivors and disability benefits
and of raising benefits for those who worked for low wages throughout their careers. Any structure that
encourages beneficiaries to compare the monthly check they receive from private accounts to the monthly
retirement check that Social Security provides thus is likely to lead to serious misunderstanding by
workers and beneficiaries of the relative value of the two systems.
The architecture of plans designed to integrate private accounts into the Social Security system,
whether by intent or effect, consequently would create a distorted picture of Social Security that
ultimately could lead many people to favor measures allowing them to withdraw from Social Security to a
greater degree. These plans thus run the risk of starting the nation down a slippery slope toward a greater
weakening of Social Security and its vital social insurance functions.
Social Security has been the crown jewel of U.S. social programs for decades, in no small part
because it is a compact not only across the generations but also among all working Americans -- the
healthy and the middle class as well as those who work for low wages and those who suffer from
disabilities. Unraveling this compact would make ours a very different, and less humane, society.
__________________
*
This box is drawn from an April 1, 2005 Memorandum ("Open Letter to Progressive Policymakers") written by Gene Sperling
and issued by the Center for American Progress.
6