Tiptoeing on the Third Rail

Friday, October 12, 2007

WHEN IT COMES to the presidential race, the problem of runaway entitlement spending is something like the weather: All the candidates complain about it, but few want to get specific about what they would do to change it. Indeed, some candidates -- the most egregious example is Sen. Hillary Rodham Clinton (D-N.Y.) on Social Security -- are happier describing what they wouldn't do than what they would. In recent weeks, however, a few candidates have ventured into this treacherous political territory. On the Democratic side, former North Carolina senator John Edwards and Sen. Barack Obama (D-Ill.) have broached the notion of fiddling with the payroll tax for those earning higher incomes. In Tuesday's Republican debate, the newest entrant, former Tennessee senator Fred Thompson, raised the possibility of changing the way Social Security benefits are calculated, indexing benefit levels to price inflation rather than to wage growth. "It would be a major step in the right direction," Mr. Thompson said.

A change in the indexing formula may sound like an arcane, minor and sensible tweak. It's certainly arcane, but it isn't minor and, at least applied as an across-the-board change, it isn't sensible, though it could be an important element of a long-term fix. Here's why: Under the current system, initial benefits for retired and disabled workers are calculated on the basis of their lifetime earnings. Social Security then applies a formula to adjust the benefit to take into account the average growth of wages during the workers' careers. (Once workers retire, their benefits are adjusted each year to reflect changes in the cost of living, but that is a different calculation from what Mr. Thompson was discussing.) Because wages tend to grow faster than inflation, tying benefits to wage growth means that, over time, retirees receive benefits that replace a constant share of their income, reflecting overall improvements in the standard of living. Switching to price-indexing would mean that the purchasing power of future Social Security benefits would remain what it is today, but those benefits would replace a much smaller share of recipients' pre-retirement earnings.

In other words, this would be a huge savings for the Social Security system -- and a huge benefit cut for future retirees from what is currently promised. How big? The Congressional Budget Office estimates that workers who became eligible for benefits in 2030 would have benefits 24 percent lower than promised under the current system if the change were implemented next year. Those eligible for benefits in 2050 would receive 40 percent less. Mr. Thompson would point out, with justification, that those expectations are unrealistic; the current system is not on a sustainable footing.

There's logic to changing the system so that future retirees aren't promised more, as they are today, than current retirees. However, a complete shift from wage- to price-indexing would be hard on lower-income workers, who rely heavily or entirely on Social Security in retirement. More sensible would be something called "progressive price-indexing," in which lower-income workers would receive the full benefit of the existing system, those in the middle would receive a blended amount and those at the top would have to make do with a benefit indexed only for inflation. That approach, with other fixes, should be on the table for Social Security discussion, and Mr. Thompson deserves credit for his bravery in at least recognizing that any fix to the system will entail some pain.

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