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April 9, 2013

Why President Obama's Social Security Fix Is Not Enough: Five Alternatives That Could Do More

April 9, 2013

The Obama administration told reporters last Friday that when the president unveils his budget later this week, he will propose trimming Social Security by slowing down the rate at which benefits increase annually to keep pace with inflation.

While changing cost-of-living adjustments (COLAs) might make sense as part of a broader effort to fix Social Security’s long-term financing shortfall, it won’t do as a stand-alone solution. In the end, the oldest Americans, and those disabled longest, would bear the brunt of this budget-cutting method.

But matters are urgent. The White House and Congress need to act soon to fix Social Security, because the system is currently paying more benefits than it receives in taxes. The trustees’ latest projections indicate the trust fund that makes up the difference will run out in 2033 under current rules. After that, Social Security would be able to fund only about three-quarters of scheduled benefits.

The sooner action is taken, the better. Most benefit-cutting proposals would protect existing retirees and those near retirement, while spreading the pain over numerous generations, so that a relative few don’t have to shoulder the burden alone. And it’s best to give people time to adjust to the new retirement rules, by working longer or saving more before they take effect.

Looking at the budget proposal’s approach, cutting COLAs would save money, but at the expense of some of the most vulnerable Americans.

The rationale for tweaking the COLA is that the existing formula is too generous. Social Security currently ties benefit increases to the change in the consumer price index (CPI-W). However, the CPI-W overstates inflation because it doesn’t fully account for quality improvements in consumer goods or consumers’ ability to shift to less costly substitutes when prices rise.

The chained CPI, an alternative measure created by the Bureau of Labor Statistics, corrects for these problems. It generally rises 0.3 percentage points slower each year than the CPI-W. That may not sound like much, but it adds up over time. The Social Security trustees project that switching to the chained CPI could reduce benefit payments by about $550 billion over the next 20 years (in constant 2011 dollars).

Those cost savings, of course, would come out of benefit checks, and the oldest retirees and long-term disabled workers would get hit hardest. Switching to a COLA based on the chained CPI would reduce benefits for an 87-year-old who began collecting at age 62 by about 7 percent, a potentially painful cut considering that half of beneficiaries in their 80s collect less than $12,000 a year.

However, the chained CPI ignores another problem with the existing COLA: it doesn’t reflect the spending patterns of older Americans. The CPI-W is based on the typical purchases of sampled wage and clerical workers. But older Americans spend more on medical care and housing.

The Bureau of Labor Statistics has constructed an experimental price index based on the spending patterns of consumers age 62 and older, but Social Security doesn’t use it. Between 1983 and 2011, that price index rose each year about 0.2 percentage points faster than the CPI-W because medical inflation surged. So the chained CPI sometimes understates the price increases that retirees experience.

But there are fairer ways to fix Social Security than changing how COLAs are determined. Adjusting the payroll tax is one option. Subjecting earnings up to about $200,000 a year to the Social Security tax would eliminate more than a third of the long-term financing gap.

Taking this step would cover about 90 percent of the nation’s wages, the same share covered in 1983 when Social Security last underwent major changes. Only about 84 percent of wages are taxed under the current system. By way of contrast, taxing all wages would eliminate nearly the entire long-term financing gap.

Other policy changes being discussed include

  • expanding the tax base to cover other types of compensation, such as the value of the health benefits;
  •  raising the retirement age;
  • bringing more state and local government employees into the system; and
  • restructuring the benefit formula to favor low-wage workers even more so than under the current system.

We’ll see what we find when the president releases his budget proposal. But if the only suggested change to Social Security is a new approach to determining COLAs, we’ll still have quite a bit of work cut out for us.

Flickr Photo by SalFalko used under Creative Commons license (CC-BY-NC 2.0)

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Comments

"Taking this step would cover about 90 percent of the nation’s wages, the same share covered in 1983 when Social Security last underwent major changes."

Another way to phrase this sentence is : Let's raise taxes to the highest levels ever attained by Social Security.

Another fact : wages subject payroll taxes has increased about 50% faster than inflation since 1983.