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Snapshot for January 12, 2005.
Proposal by the president’s Social Security commission whittles away at income support
The White House has signaled that it supports the key proposal by President Bush’s 2001 commission on Social Security to freeze future growth in Social Security benefits by fixing them to current living standards.1 This is a change from the current law, which increases benefits to reflect the life time earnings of future workers. Because American workers’ pay will most likely grow faster than inflation in the future, this change would steadily lower the share of income that Social Security would replace for retirees, the disabled, and survivors. This proposal would cut the replacement rate in half in 70 years, a major blow to low- and middle-income workers.
Since the Social Security program was enacted 70 years ago, benefits have increased as the United States has become more productive and prosperous. Congress made ad hoc increases prior to the 1970s, but since 1977 there has been a sensible formula that uses average wage gains over one’s lifetime to establish the initial level for retirement, disability, and survivor benefits. The current method effectively maintains a stable income replacement ratio over time.
By adjusting only for inflation and not for wage growth, the proposed new method for calculating benefits would effectively freeze future benefits at today’s level. For example, Social Security actuaries project that average earnings in 2005 will be $36,500—25% more than in 1970. With wages rising but Social Security benefits held fixed, over time people would absorb ever larger income losses at retirement.
The figure below depicts the steady erosion of the “replacement rate,” the share of lifetime average income that would be replaced by Social Security. Under the current system, Social Security replaces about 42% of earnings for the average worker retiring at age 65. (As a result of the 1983 compromise on Social Security, this will gradually fall to 36% as the normal retirement age is pushed back to 67.) Under the Bush commission’s proposal, the average replacement rate will fall to about 27% in 35 years, and then to 18% in 70 years.
The “price-indexing” proposal is more damaging to those in the middle and lower range of the pay scale for three reasons. First, lower and middle wage workers tend to have much less non-Social Security income to fall back on. Second, those workers are more likely to become disabled or to die young, so private account savings would be very unlikely to make up the gap in lower guaranteed benefits for them or their surviving family members, since they would have a much shorter time for their savings to accumulate and would be more vulnerable to short-term stock market fluctuations. Third, the proposal erodes the progressivity of Social Security retirement benefits. The system has progressively lower replacement ratios as income rises. For example, the current replacement rates for someone making 64% of average and someone making 64% above average are 49% and 34%, respectively, for a gap of 15 percentage points. By 2075, their replacement rates fall to 21% and 15%, a gap of only 6 percentage points. While replacement rates are dropping for all earners, low-wage earners are hit disproportionately hard by the commission’s Social Security proposal.
Social Security is a vital income replacement program for retirees, survivors, and the disabled. By providing more than 50% of income for nearly two-thirds of the elderly population, Social Security has cut poverty among the elderly by two-thirds.2 The Bush commission’s proposal would cause Social Security to wither away over time, to the detriment of lower and middle income working families.
1. Report of the President’s Commission: Strengthening Social Security and Creating Personal Wealth for All Americans. December, 2001. p. 119. This proposal analyzed favorably in Chapter 6 of the 2004 Economic Report of the President.
2. See the EPI Snapshot for November 18 titled “Social Security and Income” and Engelhardt, Gary V., and Gruber, Jonathan, 2004, “Social Security and the Evolution of Elderly Poverty,” National Bureau of Economic Research, Working Paper No. 10466 < http://www.aeaweb.org/annual_mtg_papers/2005/0107_1015_0302.pdf >.
Today’s Snapshot was written by EPI Research Director Lee Price and research assistant David Ratner.