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Three cuts to Social Security that are way, way more progressive than chained CPI

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The fiscal cliff deal is finally taking shape, and from the looks of it, it's likely to include the adoption of "chained CPI" as the government's preferred measure of inflation. As I explained last week, that measure mainly matters for taxes — where the income cutoffs for various brackets are indexed for inflation — and Social Security, in which benefits are raised annually to keep pace with inflation. Adopting chained CPI would, in effect, cut Social Security benefits and raise taxes.

That's a big slice off Social Security — $112 billion over 10 years, according to the Congressional Budget Office — and the first such cut in a while. Of more concern is how the change would affect taxpayers: It's regressive. The tax cut hits the working poor much harder than millionaires:

The same goes for the Social Security cuts. If a senior retired in 2000 under a chained-CPI system, then by this year his or her benefit would have been cut 5 percent. That doesn't matter for rich families with substantial retirement savings, but it's devastating for the working poor.

There are many progressive ways to raise money from the Social Security system. Here are three of them.

Change the Preliminary Insurance Amount (PIA) formula

Chained CPI tinkers with how Social Security benefits increase once a worker has retired. But it's also possible to change how it measures benefits to begin with.

Most people think Social Security pays out based on how much one has paid into it during his or her working years. The payout depends on how much money you were making before retirement. That's true in a broad sense, but there's a catch: The formula used to calculate the "primary insurance amount" -- the monthly payout to which one is entitled upon retirement -- is progressive.

Here are the wonky details, though I'll understand if you skip to the next paragraph if you're, you know, a normal person: First, your salaries for the 35 years (or less, if you didn't work for 35 years) in which you earned the most money are averaged, leaving out any income above the Social Security cap. This is your "average indexed monthly earnings" (AIME) figure. Then the government does a weird reverse tax procedure, starting with a high benefit "bracket" and then moving to a low one. If your AIME is less than $791 a month, then your primary insurance amount is 90 percent of your AIME. If your AIME is between $791 and $4,768, insurance  90 percent of $791 plus 32 percent of your earnings over $791. If it's over $4,768, then it's 90 percent of $791 plus 32 percent of $3,977 — the difference between $4,768 and $791 — plus 15 percent of earnings over that.

If that sounds confusing, don't worry. It's basically just a convoluted way to make the payout more progressive. It's easy to amend it, however. You just fiddle with the rates. Maybe high earners only get 10 percent of additional income in benefits, rather than 15 percent. That's what former White House budget chief Peter Orszag and economist Peter Diamond's Social Security plan would do. The cut looks like this:

Adopt progressive price indexing (PPI)

This option, floated by the George W. Bush administration in 2005, is a bigger cut than either the Orszag/Diamond reform or chained CPI, but it's much more progressive than the latter. Under progressive price indexing, poor workers would see their initial benefits indexed to wages, as described above, but rich workers would see them indexed to prices, meaning their benefits would shrink considerably. Average workers would see big cuts, too, a reason why progressive groups like the Center for Budget and Policy Priorities decry the plan.

But fundamentally, the effect would be similar to the Orszag/Diamond plan in that the curve of the benefit formula would be bent more to hit high earners, as this chart shows:

That said, the Social Security Administration has found that almost all progressive price indexing plans don't increase poverty, and that all of them raise a large amount of revenue. Even a plan that exempts 60 percent of beneficiaries from cuts, such that they only apply to the upper-middle and upper classes, would reduce the long-run budget shortfall by 31 percent, making it three times as big as the Orszag/Diamond reform.

So, progressive price indexing that exempts 60 percent of seniors would raise a ton of revenue — three times as much as Orszag/Diamond, which probably raises about three times as much as chained CPI — without hurting vulnerable seniors. It beats chained CPI on both counts.

Raise the Social Security cap

There was a time when almost all wages were subject to Social Security payroll taxes. There's always been a cap — it's $110,100 in 2012 — on wages subject to the tax. In the late 1970s and early 1980s that cap was high enough to grab around 90 percent of all wages in the economy.  But as income inequality has swiftly widened, the base for those taxes has eroded. Now, only about 85 percent of wages are taxed:

As the chart shows, that's more than it was for most of the program's history, but the trend has been downward in recent decades. So some have proposed setting the cap on wages subject to the tax so that it always grabs 90 percent of American worker's wages. According to the CBO, that raises almost $500 billion over 10  years, all from rich households earning over $100,000 a year. That's about five times what chained CPI brings in, and, again, it's much more progressive. Eliminating the cap altogether would make Social Security solvent in perpetuity.

If you insist on implementing chained CPI…

There are ways to adopt chained CPI that blunt the policy's regressive impact on seniors. The administration has hinted that it would pair the policy with a benefit bump for the oldest seniors, who are hit the most by the policy, and exempt Supplemental Security Income (SSI), which helps truly impoverished elderly, disabled and blind Social Security beneficiaries. Those are both changes that CBPP has insisted be included in a chained CPI plan.

But it's unlikely either will be enough to make the plan actually progressive. The Center for American Progress has proposed that a benefit bump for 85-year-olds be paired with chained CPI that amounts to a mere $50 a month. If the administration follows the CAP model, the effect would still be regressive. Recall that chained CPI reduces benefits by $108 a month after 12 years; the effect would be almost twice as costly for an 85-year-old who's been retired for two decades. A $50 benefit would do something to reverse that, but hardly much.