Hoover Daily Report

Nobody Is Proposing to 'Slash' Social Security Benefits

via Wall Street Journal
Thursday, February 3, 2011

Those of us concerned with the fate of Social Security watched President Obama's State of the Union address closely. We expected to learn whether the president would signal support for the proposals put forward by the bipartisan Commission on Fiscal Responsibility and Reform. But instead of commenting directly on the group's proposals—to change the benefit formula, the tax base, and the retirement age—Mr. Obama mentioned Social Security only long enough to issue vague warnings against "putting at risk current retirees" and "slashing benefits for future generations."

The president's admonitions were perplexing given the Social Security reform plans on the table. Neither Republican nor Democratic plans, nor the plan put forward by the commission, would cut benefits for today's seniors or for the poorest workers. Whether the status quo remains or the system is reformed, Social Security benefit levels will grow substantially from this point forward. That makes the president's warnings confusing at best.

To understand why, we need to start with the basics of the Social Security benefit formula. Since 1977, Social Security has employed a formula that links a retiree's initial benefit payment to growth in the national average wage index. Since wages tend to grow faster than prices, this formula pays younger cohorts greater benefits (in inflation-adjusted terms) than those paid to earlier retirees.

The rationale behind this is to provide the same replacement rate (i.e., benefits as a percentage of pre-retirement earnings) for "similarly situated" workers of different generations. In other words, if a typical worker's benefit today is 50% of his previous wage earnings, then that worker's grandson, assuming he occupies the same relative position in the national wage distribution, will also get a benefit equal to 50% of his own earnings.

What this means practically is that today's medium-wage retiree receives a benefit just below $18,000 at the normal retirement age. But benefits scheduled for a medium-wage retiree of 2050 would equal nearly $29,000 in today's dollars.

What's wrong with this formula? First, it's very expensive. As the baby boomers retire, we will soon have far more beneficiaries to support—90 million within 25 years. And if we continue to pay them according to the current formula, the inevitable result will be a huge increase in tax burdens.

Before the baby boomers began to hit the rolls in 2008, funding Social Security required less than one out of every eight dollars that workers earned. Under the current formula, workers of the 2030s will need to surrender one out of every six dollars they earn simply to fund this one federal program. A 2003 Congressional Budget Office report found that 55% of projected program cost growth was due to population aging. The other 45% was attributable to growth in real benefit levels.

The adoption of wage-indexing in the late '70s represented a significant departure from Social Security's previous rationale. The logic of wage- indexing essentially holds that even though tomorrow's $50,000 (inflation-adjusted) worker is no poorer than today's $50,000 worker, tomorrow's worker is poorer relative to those around him and should thus be entitled to a higher return than today's worker receives.

Some defenders of the current system argue that Social Security's benefits should grow with wages because, after all, worker contributions are assessed as a percentage of wages. But since Social Security is an income-transfer program in which current benefits are paid from current workers' taxes, no such proportional relationship can be preserved as society ages and there are relatively fewer workers to support each beneficiary.

To slow the growth of tax burdens, therefore, the benefit formula must grow more slowly. Current wage- indexing doesn't create benefit equity across generations. Rather, it ensures that each successive generation must pay higher taxes to get the same replacement rate.

Most responsible reform proposals recognize that the benefit formula needs to change. Under the proposal put forward by the commission's co-chairs, Alan Simpson and Erskine Bowles, for example, the medium-wage worker of 2050 would get a benefit somewhat over $24,000 (in today's dollars) at normal retirement age. This amount is not as much as the current system is promising, but still offers far more purchasing power than today's retirees possess.

In no true sense, therefore, would any current Social Security reform proposal "slash" benefits. Leaders on both sides of the aisle should acknowledge that we are actually negotiating over a rate of benefit growth. The irony in all of this is that if we dither long enough, ultimately we will indeed face the threat of benefits being "slashed" by a full 22%, according to last year's Social Security Trustees' report. It's not a reformed Social Security system that threatens to cut benefits, but the status quo—and our elected leaders would do well to acknowledge this reality.

Mr. Blahous is one of the two public trustees for Social Security and Medicare, a research fellow at the Hoover Institution, and a former deputy director of the National Economic Council. He is also the author of "Social Security: The Unfinished Work" (Hoover Institution Press, 2010).