Saving Social Security: Why New Proposals Are Drawing Fire

On April 10, President Barack Obama released his $1.8 trillion budget proposal for fiscal 2014, which included a controversial — but not altogether surprising — plan to change how Social Security benefits are calculated. Rather than using the Consumer Price Index (CPI) to calculate cost-of-living adjustments to Social Security, the President proposed switching to “chained CPI,” which would take into account the possibility that when prices rise for certain goods and services, consumers buy cheaper products instead. Using the chained CPI method would save the federal government an estimated $230 billion over the next decade.

Still, the proposal drew fire from all corners, with both Democrats and Republicans complaining that the President is crippling a vital entitlement program — retirement security that all Americans have come to expect. On April 22, Rhode Island congressman David Cicilline and 81 other Democrats introduced a resolution rejecting Obama’s chained-CPI proposal. “We should not expect Rhode Island seniors to sacrifice their earned Social Security benefits to fix fiscal problems that they had no hand in creating,” Cicilline said in a statement.

Despite the controversy, virtually no one disputes that America’s Social Security system needs to be shored up somehow. “Over the next 25 or so years, the demographic change in this country is going to be extraordinary,” says Mark Duggan, Wharton professor of business economics and public policy. According to the U.S. Census Bureau, the number of non-elderly adults will grow by 11% between now and 2040, while the number of adults 65 and up will skyrocket by 93%. “What that means is the ratio of non-elderly adults to elderly adults is going to go from 4.7 to 1 today to 2.7 to 1 by 2040,” Duggan says. “The effects of that on the government’s budget are going to be so massive that anything that can help to address this challenge will be useful.”

So what exactly is chained CPI? In short, it’s a way of linking the substitutions people make in their spending habits to the CPI. “For example, suppose I buy an equal number of apples and bananas each week, and the price of apples goes up by 10%, while bananas don’t go up at all,” Duggan says. “The CPI would say I’ve seen an increase in inflation, when in fact I’m probably going to buy more bananas.” Usually, the chained CPI is about a quarter of a percent lower than the normal CPI.

Translating that fraction of a difference to Social Security payouts would yield a small decrease in the rate at which the payouts grow. “Say I’m 66 years old and my payment starts at $1,000 a month,” Duggan says. “Instead of growing to $1,030 in that first year, it would grow to $1,028. That second year, instead of growing to $1,060, maybe it would grow to $1,055.”

Duggan believes that because the change is so gradual, it would give working people plenty of time to adjust their savings habits so they are better prepared for retirement. “It doesn’t have any effect on the initial benefits people would receive,” he says. “It is true that by the time you get to 85 or 90 years old, a quarter percent per year over 20 years can add up. But the benefit of a policy like this is that you give people plenty of time to plan.”

That’s not how the critics see it, though. In a statement in response to the President’s proposals, the AARP said chained CPI would take “money from the pockets of current beneficiaries, and would grow larger over time, having the greatest impact as Americans grow older and rely more on their Social Security benefits.” The AARP advocates studying alternative methods for calculating inflation, including the CPI-E, an experimental measure developed by the Bureau of Labor Statistics that looks specifically at the spending habits of people over age 62.

Kent Smetters, Wharton professor of business economics and public policy, warns that CPI-E has some major drawbacks.First, he says, it doesn’t reflect qualitative changes in spending habits like chain-weighted measures do. “Second, it likely over-weights medical inflation, because it does not try to measure the out-of-pocket medical expenses paid by the elderly. Instead, it simply places more weight on medical spending in general.”

Debating Alternate Strategies

Medical spending by the elderly adds a wrinkle to inflation that’s difficult to reconcile with CPI-E, says Olivia S. Mitchell, Wharton professor of business economics and public policy. “I’ve never been convinced that there’s a very good measure of the market basket that the elderly consume. Part of the reason is that many of them consume a lot more medical care than younger people do,” she notes. “And the medical care is heavily subsidized by Medicare. Should you really include the medical care that is being subsidized by this other government program?”

Mitchell advocates a system that would ease poverty among the elderly, but “not with a crude tool such as a different CPI measure,” she says. “Not everyone in the elderly population needs to be subsidized. It seems to me the right approach is to measure [overall] inflation correctly, and separately to pay attention to those who are below subsistence. I would de-link the CPI question from whether or not we need to do more to help the elderly.”

Obama’s 2014 budget proposal also includes a $3 million cap on Individual Retirement Accounts (IRAs) and other tax-preferred accounts. That might help close the budget deficit, Mitchell says, but it could also have unintended consequences. “The problem is that what we need is more saving — not less. By capping the retirement accounts, it’s going to discourage savings.”

In 2001, Mitchell served on the President’s Commission to Strengthen Social Security, a bipartisan group that, among other proposals, suggested adding a private-investment option to the plan. The group recommended that, on a voluntary basis, working individuals could take 4 percentage points out of their payroll tax and invest it in a personal account. “We had a fairly strict set of investment alternatives. You couldn’t take the money and run; you couldn’t invest it all in a company’s stock. Basically, you had to invest it in an index fund or something like it,” she says.

President George W. Bush supported the plan, but it never gained much traction. “I think the concern at the time for many people was that the stock market had been very volatile. There was a tech collapse, so some people thought it was too risky,” Mitchell says. “On the other hand, our analysis was that the current Social Security system collects everybody’s payroll tax and gives it to the Treasury, and then the Treasury spends the money. That’s risky, too. It was our view that it would probably be politically more sustainable to give people some degree of control over a portion of their Social Security than it would be to give it to Congress — which, as we know, keeps overspending.”

More recently, Mitchell adds, some have proposed letting the federal government invest a portion of the money that comes into the Social Security system. “I think that raises all kinds of red flags, because then you have governments picking stocks and intervening in corporate valuations. That’s a very rocky road to take.”

Getting off Autopilot

Another oft-proposed reform for Social Security is “means testing,” a system whereby retired workers and their dependents and beneficiaries would have their benefits reduced if their wealth exceeded pre-determined thresholds. Some have suggested that means testing should only include wealth-related income, such as investments, while others say it should take into account all sources of income. Either way, the result would be the same: Means testing would lessen the overall Social Security burden by lowering, or even eradicating, payments to the most well-off individuals.

“We have one element of means testing already in Social Security, and that’s the taxation of benefits,” says Donald Fuerst, senior pension fellow for the American Academy of Actuaries in Washington, D.C. “Up to 85% of benefits received are taxable for people with higher incomes. That’s a form of means testing. People with very low incomes don’t pay that tax.”

Whether such means testing should go further than that is open to debate, Fuerst says. No one disputes that such a move would save the system billions, but it’s the other ramifications of means testing that need to be considered. “There’s a potential erosion of public support for the whole program if [means testing] takes place. It could be viewed much more as welfare as opposed to social insurance or something that people are entitled to in their retirement.” And similar to the proposed cap on IRA investing, means testing could create disincentives for people to save. “If the means testing were based on wealth, you would have an incentive for people to make sure their wealth was below whatever the threshold was for getting full social security benefits,” Fuerst notes.

In any case, he adds, none of the proposed changes to Social Security should be viewed in a vacuum. “We would much prefer to see the CPI looked at as one component of more extensive changes that need to be made to Social Security to make it sustainable for the long term,” Fuerst says.

As if there’s not enough to worry about with just the medical portion of Social Security, Duggan points out that the disability insurance benefits provided by the plan are in grave danger of insolvency also. In fact, the disability program’s trust fund is projected to run out of cash in 2016, resulting in massive benefits cuts to 11 million Americans. “Disability is not front and center, yet it’s a big part of the entitlement program challenge,” Duggan says. The number of disabled workers has doubled since 1995, according to the Center on Budget and Policy Priorities in Washington, D.C. “At some level, technology has made it easier to work if you have a disability, yet what we’re seeing is an ever-declining share of people with disabilities who are working. It’s a perfect example of the kind of thing the country ought to be working harder at, but politically it’s a very tricky issue, because there’s this group of individuals who want [Social Security] to be more generous, not less.”

Duggan is optimistic that legislators will eventually come to some sort of compromise for strengthening Social Security, especially as immediate pain from current budget cuts affects a wider swath of Americans. “The sequester throws cuts on things like education and air traffic control. But the entitlement programs have really been on autopilot for 30 years,” Duggan points out. “In light of the demographic change on the horizon, why should the nation’s young people bear the burden of the cuts?”

Citing Knowledge@Wharton

Close


For Personal use:

Please use the following citations to quote for personal use:

MLA

"Saving Social Security: Why New Proposals Are Drawing Fire." Knowledge@Wharton. The Wharton School, University of Pennsylvania, [24 April, 2013]. Web. [20 April, 2014] <http://knowledge.wharton.upenn.edu/article/saving-social-security-why-new-proposals-are-drawing-fire/>

APA

Saving Social Security: Why New Proposals Are Drawing Fire. Knowledge@Wharton (2013, April 24). Retrieved from http://knowledge.wharton.upenn.edu/article/saving-social-security-why-new-proposals-are-drawing-fire/

Chicago

"Saving Social Security: Why New Proposals Are Drawing Fire" Knowledge@Wharton, [April 24, 2013].
Accessed [April 20, 2014]. [http://knowledge.wharton.upenn.edu/article/saving-social-security-why-new-proposals-are-drawing-fire/]


For Educational/Business use:

Please contact us for repurposing articles, podcasts, or videos using our content licensing contact form.

 

Join The Discussion

No Comments So Far