Reform Calculations


by Matt Moore   

The Washington Times

The Bush administration has suggested shifting the calculation of initial Social Security benefits from wages to prices to reduce costs. Reporters and pundits flew into a tizzy as if this were breaking news. But the indexing proposal has been discussed publicly since it was developed three years ago.

While the president has not endorsed a specific Social Security reform plan yet, news reports suggest the administration will point Congress toward one of the frameworks developed in 2001 by the Commission to Strengthen Social Security (CSSS), commonly called Commission Model 2.

Model 2 basically makes two changes to Social Security:

  1. It changes the indexing of initial benefit payments to reduce the government's obligations, eliminate the program's daunting $11 trillion debt and return the program to solvency.
  2. It lets workers to own a Personal Retirement Account (PRA), so those affected by the first provision can earn most of the money back.

Model 2's indexing provision would change the indexing of initial benefit payments from wages to prices (or inflation). Initial benefits are set by a complex formula that calculates a worker's earnings in his 35 highest-paid years and adjusts them upward to reflect the standard of living when the worker retires. Under current law, that adjustment is based on the growth in wages. Model 2 would change the formula so the adjustment would be based on the rise of consumer prices.

Because wages rise faster than inflation (by about 1.1 to 1.2 percent yearly), the new formula would slow the growth of future initial benefit payments, gradually reducing initial benefits by a third over the next seven decades.

This provision affects calculation of benefits in the first year of retirement. Once initial benefit payments are determined, retirees will still receive cost-of-living increases each year, just as under current law. Today's current and near-retirees would not be affected. But how would it affect future retirees?

Again, the provisions in Model 2 aren't new. The Social Security Administration, the Congressional Budget Office, the Government Accountability Office, the Senate Aging Committee, a host of think tanks and others have studied the plan in depth. We know what the plan will do, and we can be reasonably sure how the plan will affect future workers.

Imagine a median-wage ($35,000 per year) 29-year-old worker who will retire in 2042. Social Security promises that worker a benefit of about $21,800 (in 2004 dollars). This level is wage-indexed and is some 50 percent higher than a median-wage retiree received last year.

Now, suppose this initial benefit level is price-indexed instead of wage-indexed. In that event, the worker's Social Security benefit would be about $16,300 - that is 25.7 percent lower than under current law.

This might seem a raw deal if it were the end of the story, but there's more. Model 2 would also allow workers affected by the indexing changes to earn back some of the money with a personal retirement account (PRA). Model 2 gives workers the opportunity to create PRAs by investing 4 percentage points of the 12.4 percent payroll tax they already are paying.

The Social Security Administration analyzed benefit payments under Model 2, and assumed participants' PRAs earned a conservative 4.6 percent a year. With the indexing change and the PRA, our worker would have earned a benefit of $20,500, or 94.1 percent of what Social Security promises.

When examining the costs and benefits of such a change, it is also important to remember Social Security cannot afford to pay workers what it promises. If no changes are made, in 2042 when the last of the Trust Fund's bonds have been cashed in, the program can only afford to pay 74 percent of benefits.

Therefore, the numbers deserve to be restated. A medium earner ($35,000) retiring in 2042 would receive a benefit under Model 2 that is 128.8 percent of what Social Security can afford to pay him under current law. Lower-income workers fare even better. A low-wage worker ($16,000) retiring in 2042 would receive a benefit that is 150 percent higher than Social Security can afford to pay and 110 percent of what the program even promises, thanks to his personal account and the new minimum benefit rules in Model 2. That's not a bad deal, especially given that Model 2 eliminates the program's $11 trillion debt and restores program solvency by midcentury.