Benefits-slimming plan clarified

04/30/2005

April 30, 2005


We’ve been told for years that fixing Social Security’s long-term solvency problems would require painful choices.

President Bush just made one.

In his news conference Thursday, Bush embraced a new way of calculating Social Security benefits that would eliminate most of the system’s projected deficit, but would also cut benefits for more than two-thirds of future retirees.

The younger you are, and the higher your wages, the bigger your cut would be. In a rare, worst-case scenario, the cut could be as much as 49 percent. For a more typical 30-something making average wages, the cut would be more like 12 percent.

The concept Bush proposed is called “progressive indexing.” It was developed by Robert Pozen, a Massachusetts investment executive who sat on Bush’s 2001 Social Security commission. Here are some basic questions and answers about the proposal and how it might affect you.

Q: How does it work?

A: First you have to understand how Social Security benefits are calculated now. The Social Security Administration takes the average of your highest 35 years of earnings, and adjusts that figure upward to reflect the growth of average wages during your working lifetime. That figure, called your average indexed monthly earnings, is the key to your initial benefit.

The Pozen proposal would—if you’re among the top 70 percent of wage earners—adjust your earnings according to the growth in prices, instead of wages.

Q: What difference does that make?

A: Historically, wages have grown about 1 percentage point a year faster than prices. If that continues, the switch to the price inflator would produce a substantially lower retirement benefit than the wage inflator.

Q: How much lower?

A: That depends on several factors. In the absolute worst-case scenario, a worker who will turn 65 in 2075 and whose wages will be at or above the Social Security wage cap (currently $90,000 and rising) throughout their working lives would get a benefit cut of 49 percent compared with the benefit they would get from the current formula. That’s according to an analysis of Pozen’s proposal by the chief Social Security actuary.

Q: But this applies only in the distant future in a rare case of a very well-paid person who isn’t even born yet.

A: And in comparing the future benefit under Pozen’s plan to the current benefit formula, you need to keep this in mind: There’s a price to be paid to maintain today’s higher benefit formula. Workers would have to pay higher payroll taxes to keep the program solvent beyond 2041.

At the other end of the spectrum, if you are 55 or older, or if you are in the bottom 30 percent of wage earners, the change would have no effect on your benefits. In terms of today’s wages, the bottom 30 percent are those with annual incomes of $20,000 or less.

Q: What if I’m in between the top and the bottom?

A: You would get something in between your currently scheduled benefit and the 49 percent cut in the worst-case scenario. Exactly where you would fall on that scale depends on two main factors: your current age and your average wage over your working lifetime.

For example, the 30-something mentioned above is a hypothetical 35 year-old, currently earning the U.S. average income of $36,500. Assuming he continues to earn the average wage, he would get a 12 percent benefit cut. A current 45-year-old in the same income bracket would only get a 6 percent cut. A 25-year-old would get a 16 percent cut.

Q: How does my age come into it?

A: If you are in the middle of your working life, the old formula will apply to the years you have already worked; the new formula would apply to future years. The more years that are subjected to the new formula, the more it would reduce your benefit.

Q: Didn’t Bush say at his news conference that future generations would get benefits equal to or greater than what today’s retirees get?

A: Yes, he said that. It’s true that in unadjusted dollars, future benefits under the new formula would be higher than current benefits. But as a percentage of a worker’s wages, future benefits would be less for the top 70 percent.

Under progressive indexing no one gets an increase over the current benefit formula except in a hypothetical case of someone who opts for one of the personal investment accounts that Bush hopes to add to the Social Security system and who does very well with their investments.

The Social Security actuary who analyzed the Pozen plan and the investment accounts concluded that, on average, most people who took the optional accounts would have total benefits lower than what they would get under the existing benefit formula.

Q: Oh yeah—the investment accounts. What does that have to do with the progressive indexing?

A: Not much. If Bush’s idea for partially privatizing Social Security is enacted, workers younger than 55 would have the option of investing in mutual funds 4 percentage points of the 12.4 percent Social Security payroll tax. But if you take that option, you have to accept a cut in the guaranteed portion of your benefits.

If progressive indexing is enacted and you are among the top 70 percent of earners you would get the benefit cut whether or not you take the investment option. The benefit cut because of the indexing change is designed to reduce the shortfall in Social Security after 2041, when the Social Security Trust Fund is projected to be depleted.

Q: How much of the shortfall does it eliminate?

A: The White House estimates about 70 percent.

Q: How would the remaining 30 percent of the shortfall be eliminated?

A: Bush hasn’t said, but he has repeatedly asked members of both parties to put ideas on the table for shoring up Social Security’s finances. The only things he has ruled out is raising the payroll tax rate and cutting benefits for those already at or near retirement.

He has expressed a willingness to consider ideas ranging from raising the retirement age to raising the wage cap on which payroll taxes are levied.

Before Thursday night, he was often criticized for failing to embrace any of the painful benefit cuts that would be necessary.

Q: Is it possible to just change the benefit formula and not create the option of private accounts?

A: Theoretically, yes. Bush was asked Thursday whether he would accept a bill that eliminates Social Security’s projected deficit but doesn’t create the account option. He didn’t swear to veto the idea, but he strongly advocated the personal accounts option. And he has said since 2001 that Social Security reform must include the accounts.

Q: What happens next?

The Senate Finance Committee has begun hearings on Social Security. On Friday, Rep. Bill Thomas, chairman of the House Ways and Means Committee, said he would begin hearings on May 12.