- The Washington Times - Tuesday, May 3, 2005

On April 28 President Bush, to his credit, bit the bullet and proposed cuts in future Social Security benefits that would significantly reduce the projected long-term deficit.

His plan would cut into the inflation-adjusted benefits of high- and medium-wage workers, but shield low-paid retirees from reductions. In the president’s words, “I propose a Social Security system in the future where benefits for low-income workers will grow faster than benefits for people who are better off.”

Under current law, the initial benefits of Social Security recipients are indexed to the national average wage. The president expressed support instead for a progressive indexing scheme that works on a sliding scale. Low-wage workers would continue to have their benefits pegged to average wage growth, but high earners would have their initial benefits indexed to inflation, and the initial benefits of midlevel earners would be partly wage indexed and partly price indexed.

Historically, wages have risen faster than prices, by about a percentage point a year thanks to productivity growth, so the progressive indexing plan would raise benefits faster for low earners than for higher-paid workers.

Progressive wage-price indexing of Social Security was originally proposed by Boston businessman Robert Pozer, a member of the president’s 2001 Social Security Commission. His plan has attracted considerable attention in Congress as well as the White House — even though it contains a ticking time bomb that in time will level retirement benefits across wage groups.

Compression of all retirees’ benefits over time is implicit in the progressive indexing formula. The benefits of low-wage workers would increase the fastest, medium earners more slowly, and high earners still more slowly. Compared to what is now promised, the real benefits of middle- and high-wage groups would be cut, the higher the earnings the bigger the cut. The difference in benefits between earnings groups would inevitably narrow and eventually disappear. Social Security thus becomes the ultimate welfare system, the grand leveler.

Social Security already provides extra help for low-wage workers by replacing a larger share of their past earnings upon retirement than for higher-wage workers. Progressive indexing would go further by effectively severing the link between earnings and benefits.

In an April 22 report on progressive wage-price indexing, the Congressional Research Service (CRS) of the Library of Congress confirmed “indexing would lead to the same benefit for all workers.” How much or how fast benefit differentials among earnings groups would narrow and approach zero depends on the gap between inflation and wage growth.

Productivity growth in the long run raises wages and restrains inflation. For the past decade, the trend in productivity growth has risen above its long-term average, and many economists expect the higher growth rate to persist. Under a Social Security plan that’s progressively indexed, a higher rate of productivity growth means benefits for low-wage earners would rise even faster relative to higher earners, thereby accelerating equalization. The faster productivity grows, the greater the squeeze on the majority of workers. And since future productivity, wages and prices are not very predictable, workers’ future benefits would become more of a mystery.

As the CRS analysis points out, “somewhat paradoxically, if real wages rise faster than projected, price indexing would result in deeper benefit cuts, even as Social Security’s unfunded 75-year liability would be shrinking.”

The leveling issue is bound to become a political hot button. It’s uncertain if middle-income workers, who would continue to have their earnings taxed at a high rate but whose benefits in real terms would shrink, would tolerate a sharper narrowing of differentials between earnings classes. Excessive redistribution can breed resentment and risks dampening worker motivation.

Here, it seems, we have a plan in need of repair. One straightforward solution (among others) to help solve the leveling problem would be to use either wage indexing or price indexing across the board. A constant, say a fraction of a percentage point, could be added to the inflation rate to calibrate benefits and determine how much of the trust fund deficit policymakers want this feature to reduce.

Similarly, a constant could be subtracted from the wage index to arrive at the desired deficit reduction. A benefit floor to protect low-income retirees could be integrated into the plan by adding a refundable tax credit to the income tax system.

What we don’t want is a combined wage-price indexing plan that too severely punishes the most productive workers in order to redistribute their income to the less productive. In our market economy, one worker’s wage is higher than another’s because his or her productivity is higher. Workers’ skills are hard-won. If too big a chunk of the rewards of greater efficiency is taken from the more productive and transferred to the less productive, perverse disincentives inimical to economic growth can result. That would only make the Social Security financing problem worse.

Alfred Tella is former Georgetown University research professor of economics



Click to Read More

Click to Hide