Will Bush's latest pet idea kill Social Security?

The search for better economic policy.
May 3 2005 5:45 PM

Pozen Pill

How Bush's version of "progressive indexing" would kill Social Security.

Will this man kill Social Security? 
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Will this man kill Social Security?

George W. Bush has come out in favor of a proposal for cutting Social Security benefits called "progressive price indexing."Or has he? On May 1, White House Chief of Staff Andrew Card appeared on Meet the Press. A proposal by Robert Pozen "... is really not necessarily the president's plan," Card noted. "It's directionally consistent with the president's plan." So what does Pozen say, and where does Bush differ? As everyone knows, Social Security has a problem: The current level of dedicated Social Security taxes is very unlikely to bring in enough money to fully pay the benefits currently specified by law beyond the middle of this century. Social Security taxes will have to go up, Social Security benefits will have to be cut below currently projected levels, or other tax revenues will have to be earmarked to pay Social Security benefits.

Robert Pozen proposes to fill the post-2050 projected funding gap by using other tax revenues and reducing benefits. He would fill 30 percent of the hole by tapping into income tax revenue. He would fill another 10 percent of the hole by cutting Social Security disability payments. He would fill 60 percent by shifting to "progressive price indexing" of the Social Security retirement benefit formula. That means cutting benefits relative to current-law projected levels for people at the top and the middle.

To understand where Bush might be going with this, let's first review how Social Security works. People contribute to the program through Social Security taxes—12.4 percent of their wages, up to a maximum payment of $11,260 a year taken from them and their employers. In return, they get a disability insurance program, a survivors' insurance program, and a prescribed level of retirement income that's protected against inflation.

The retirement-income component of Social Security provides a better relative deal to the working poor than it does to the relatively rich. For somebody making half the average wage (that is, making $18,000 a year today), Social Security benefits "replace" 49 percent of pre-retirement earnings. For somebody making the average wage ($36,000 a year today), the "replacement rate" is 36 percent. For somebody making the maximum taxed by Social Security ($90,000 this year), it's only 24 percent. This declining replacement-rate benefit formula makes sense: Social Security returns relatively less to high earners, who are more likely to have other retirement savings. But it's not supposed to be a means-tested welfare program: Someone at the Social Security maximum wage gets a check about two-and-a-half times as large as someone making half the average wage.

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Now let's look at Pozen's numbers for those retiring in 2075. Pozen would keep the replacement rate at 49 percent for the working poor—those making half the average income. But the replacement rate for those making more would be cut: At the average income, the replacement rate would go from 36 percent to 26 percent; at one-and-a-half times average, from 30 percent to 17 percent; at the Social Security maximum, from 24 percent to 12 percent. Pozen's proposal gradually turns Social Security from a program in which benefits rise with incomes to one in which nearly everybody's benefit is roughly the same: about $1,900 of today's dollars a month. These are ferocious benefit cuts for those at or above average incomes—an across-the-board benefit cut of about one-seventh would do as much for Social Security's overall finances. But that's the point. Pozen's central aim is to keep the poorest one-third of beneficiaries from bearing any of the burden of future benefit cuts.

This sounds like a not unreasonable way to keep Social Security healthy through most of the century. And progressive price indexing, by itself, is neither left-wing nor right-wing. Insulating the working poor from benefit cuts and tapping income-tax revenues to fund Social Security is "liberal." For Social Security to become a flat-benefit guardian against destitution, rather than a substantial base line layer of retirement income for everyone, is arguably "conservative." But when you combine Pozen's progressive indexing with Bush's separate proposal for private accounts, it becomes something different: a way of phasing out Social Security altogether. Here's how:

Pozen's proposal caps the maximum Social Security retirement benefit at roughly $22,500 dollars a year (adjusted for inflation). Bush's private-accounts plan—which would allow people to contribute 4 percent of their wages—makes retirees repay the taxes they diverted into private accounts out of their standard Social Security benefit. Medicare premiums are already deducted from your Social Security check. Deduct the claw-back for the private-accounts diversion as well, and by late in this century the odds are that—at least for the upper middle class—the standard Social Security check would be zero. Social Security would no longer be a universal program: It would be a program in which the half of America that is richer and more powerful and more likely to vote sees large chunks of its money going in and nothing coming out.

Even without private accounts, aggressive means-testing a la Pozen risks undermining Social Security over time. Insulating the poor from cuts is a left-wing goal. But it will create a large class of Americans who get much, much less out of Social Security than they put in and for whom Social Security as a whole is demonstrably a very bad deal. Early Social Security guru Wilbur Cohen may well have been correct in his belief that "in the United States, a program that deals only with the poor will end up being a poor program. ... " Loading a large chunk of the burden of fixing Social Security onto America's upper middle class may be the first step in the creation of a mid-21st-century political majority for the phasing-out of the program as a whole.

Viewed in this way, Bush's embrace of a program to make the distribution of income more equal can be explained as a Trojan horse to eliminate Social Security in the long run. That must be what Bush is thinking, right? It's not that he's suddenly worried that the working poor don't get a large enough share of America's wealth, right?

But quite possibly wrong. It's also possible that the White House is just desperate to somehow generate forward motion on Social Security, and that it hopes that a fiscally progressive policy change will be popular. Bush's recent press conference did not illuminate much, and the information released smelled as though the administration did not fully know what it was doing: The headline numbers made sense only if Pozen's proposal to cut disability benefits was also part of the package, but Bush expressly said disability benefits were not to be touched.

So what, exactly, are the pieces of Pozen's proposals that Bush has signed on to? Will the next step be a proposal for income tax increases to cover the rest of the funding gap? Is there a second round of benefit cuts coming—possibly targeted at the poor? When it comes to the administration's ideas for Social Security, we're back where we started. No one knows.

Brad DeLong is a professor of economics at U.C. Berkeley and a research associate of the National Bureau of Economic Research. Click here to read his blog.

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