Report | Retirement

Social Security price indexing proposal means benefit cuts for workers

Issue Brief #209

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Social Security price indexing proposal means benefit cuts for workers

By William E. Spriggs and David Ratner

Much has been made of the recent Social Security proposal put forth by Robert Pozen, a member of Bush’s President’s Commission to Strengthen Social Security, and endorsed by President Bush. Pozen’s suggested changes to Social Security include blending the current wage indexing of benefits with price indexing, a shift that will reduce Social Security benefits for middle-income workers by 22% in 2055 and by 28% in 2085. Indeed, the Pozen proposal will lead to substantial and ever increasing benefit cuts for well over 70% of Social Security beneficiaries, including retirees, widows, and surviving children.

Earlier projections discussing implications of the effects of Pozen’s proposal concern only workers who are either very young or not yet born. As a result, the cost of price indexing for current workers has been missing from the debate. These new estimates focus on current workers and, while remaining consistent with the proposal’s long-run projections, show substantial benefits cuts under the Pozen plan for them as well. These expanded numbers also include estimates for each state for different ages and national estimates for race, gender, and marital status.

Wage indexing versus price indexing
The Pozen proposal cuts projected Social Security benefits by taking advantage of the fact that average wages have grown (and will continue to grow) faster than prices. Because the gap between wages and prices grows over time, the benefit cuts under the Pozen plan deepen over time. Thus, the cuts for those currently employed will not be as large as for those not yet old enough to be employed.

The cuts in benefits for current American workers should be put in the context of other changes in sources of retirement income. Retirement Income: The Crucial Role of Social Security, a recent Economic Policy Institute study by Christian Weller and Edward Wolff, highlighted the declining share of Americans with access to traditional retirement accounts and the dramatic growth of Social Security as a share of middle-class retirement wealth. For instance, for those ages 47 to 55, Weller and Wolff show that about 26% of workers have neither a defined benefit nor a defined contribution pension plan. And, for workers in that age group, the mean value of their private pension plans was less than the wealth they held in Social Security benefits. In that context, the cuts from the Pozen plan would be devastating.1

The tables below use data on workers gathered by the U.S. Census Bureau on annual income for the three most recent years of data (2001 to 2003). By creating such a large sample of current American workers, we can project the loss of Social Security retirement benefits that specific groups of current workers can expect to receive (see the Technical Appendix for a full explanation of the data and methods). The tables present the proposal’s effects for workers currently married and the expected benefit cuts by state, race, gender, and age.

Under the Pozen proposal, about 6% of workers who earn enough to get the maximum Social Security benefit will have their future benefits calculated using pure price indexing (currently those earning more than $90,000 a year would receive the maximum benefit). The benefit cuts are largest for these workers with the highest earnings. Roughly the bottom 30% of earners—but, importantly, not the bottom 30% of Social Security beneficiaries—will have their benefits calculated using the current method of wage indexing. And the remaining workers—the roughly 64% of those between the bottom and the top of the earning scale—will have their benefits cut, with those at the lower end facing smaller cuts than those at the higher end.

Pozen plan will slash benefits for many current workers
According to testimony by the director of the Congressional Budget Office on May 25 , the Social Security trust fund should be able to pay full benefits another 39 years, through 2044.2 Thus, under the current Social Security framework, workers now in their early 40s should receive full benefits in retirement for their expected lifetimes. Anyone younger than that would unambiguously suffer from a cut in benefits if Congress passes Social Security reform with the Pozen proposal for indexing benefits.

But while older workers will be hit with reductions in benefits under the Pozen plan, younger workers will take the biggest cuts in benefits. As shown in Table 1,Adobe Acrobat (PDF) the average cut for today’s 26-year-old workers will be 14.6% compared to current law, and will amount to a reduction in retirement income over their expected retired lives of $71,236 in today’s dollars. Today’s 40-year-old workers will suffer a cut of 7.3%, amounting to a cut of $28,148 in benefits in today’s dollars. Given that under current law, and with current projections, Social Security should be sufficiently solvent to pay full current law benefits, these are substantial and unnecessary cuts.

It is important that policy makers approach any cuts in benefits to current workers with caution. In 1997, the Social Security Trustees reported that the projected 75-year shortfall in Social Security’s finances were equivalent to 2.23% of taxable payroll for the United States. Yet, no changes were made in the program. Over the last eight years, the shortfall estimated by the Trustees’ report has narrowed by 14% to 1.92% of payroll, mostly because the economy performed better than predicted.3 So, if cuts in benefits had been implemented to eliminate the shortfall projected by the Social Security trustees in 1997, those cuts would have been far deeper than necessary, based on what we know about the projections made today.

Marital status and gender under the Pozen plan
Because men have been earning more than women, men will face a greater cut in benefits than women. Young men ages 26-31 can expect cuts in benefits of 13.8%, amounting to a drop in expected retirement income over their lives of $62,686 in today’s dollars (see Table 2Adobe Acrobat (PDF)). It will be difficult for these men to earn back enough by retirement to offset a cut that large, even with the most generous assumptions about how private accounts might perform.

Married couples will take a bigger cut in benefits than single workers. This is primarily because married men tend to earn more than single men or women. Wives are allowed to claim either their own benefit, based on their work record, or half their husband’s benefit, based on his work record. So, some women who appear to be low wage, actually will take a larger benefit cut. For married couples age 42-54, the cut will be 3.9% each, and will average a cut of $14,373 each in retirement income (as shown in Table 3Adobe Acrobat (PDF)). Against the backdrop that Social Security would be able to pay these benefits in full, that is a large cut. And, watching the private pension plans of Enron, United, and others vaporize in the wake of the stock markets downturn, those cuts will be difficult to make up from oth
er resources before these workers retire.

Social Security cuts by state
Examining the Pozen proposal through the lens of its impact on individual states yields further evidence of the proposal’s negative effect on Social Security benefits. As Table 3 showed, married couples take a bigger cut than singles. And, as the logic of the Pozen plan protects the bottom third of earners, states with more low earners will have lower cuts than states with more high earners. Part of the reason that some states have deeper cuts than others comes from differences in marriage rates, as well as in incomes.

Projected cuts for states reflect average income for workers, and the share of workers in each state who are married (see Table 4Adobe Acrobat (PDF)). Among states, current workers in Massachusetts, New Jersey, Connecticut, and Delaware will take the greatest loss in Social Security income, though Virginia and Pennsylvania also rank high.

Racial differences in benefit cuts
Again, because the Pozen plan cuts benefits more for workers who make more, racial differences in the size of cuts will depend on racial differences in income. Racial differences in cuts reflect the higher earnings of whites and Asian Americans than of Hispanics and African Americans (Table 5Adobe Acrobat (PDF)). Despite a smaller cut for African Americans and Hispanics—an average of 2.8% for 42- to 54-year-olds compared to 3.8% for whites and 3.7% for Asian Americans in that age group—the greater share of African Americans and Hispanics who rely solely on Social Security for their retirement income will make these cuts appear larger relative to their total retirement income. (The amount of lost retirement income is projected to be slightly higher for African Americans because a higher share of African Americans are women than is true for Hispanics, and women have longer life expectancies than men.) It bears repeating that the Pozen plan would impose cuts on 42-54 year olds even though projections show that Social Security will have sufficient funds to pay full benefits throughout the expected life of this age group.

Given the certainty that the current work force will face benefit cuts under the Pozen plan, a careful analysis must be made of the impact of those cuts. For instance, 42-to 54-year-olds will face smaller cuts than younger workers, but their cuts are not the direct outcome of Social Security projections showing insufficient funds to cover their benefits. And, cuts for 42- to 54-year-olds will take place when many have been surprised by the sudden drop in their private pension plans and have little time to recover the losses in retirement income that will stem from private plans or cuts in Social Security. Using cuts to balance the Social Security Trustees projections must be weighed carefully in light of the fluctuations in the Trustees’ projections over time. Had cuts been made in 1997 to close the 75-year actuarial shortfall projected at that time, they would have been deeper than what would be required to close that shortfall today.

Research assistance by Danielle Gao is gratefully acknowledged.

Endnotes
1. Christian Weller and Edward N. Wolff, Retirement Income: The Crucial Role of Social Security (Washington, DC: EPI, 2005).

2. Douglas Holtz-Eakin, “Options for Social Security: Budgetary and Distributional Impacts,” statement, U.S. Congress, Senate, 109th Congress, 1st Session, Committee on Finance, Hearings: Social Security: Achieving Sustainable Solvency, May 25, 2005 at http://finance.senate.gov/hearings/testimony/2005test/dhetest052505.pdf.

3. U.S. Congress, House of Representatives, 109th Congress, 1st Session, Committee on Ways and Means, The 2005 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, (Washington, DC: U.S. Government Printing Office, 2005): Table VI.B1.—Long-Range OASDI Actuarial Balances as Shown in the Trustees Reports for 1982-2005at http://www.ssa.gov/OACT/TR/TR05/tr05.pdf.


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