Economic Snapshot | Retirement

Proposed Social Security price indexing would slash benefits

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Snapshot for February 9, 2005

Proposed Social Security price indexing would slash benefits

The Bush Administration has spoken favorably about substituting price indexing for wage indexing, a change that was a centerpiece of Plan 2 of the President’s Social Security commission.  Under this change, benefits would no longer reflect improvements in the country’s standard of living, but would just be indexed to prices.  It is hard to overstate the effect of that substitution on hypothetical future benefits. 

Recent research by the non-partisan Congressional Research Service (CRS) sheds light on this issue.  The CRS estimated what the effect on current Social Security retirees’ benefits would have been if initial benefits had been calculated based on increases in prices—using the consumer price index—instead of increases in average national wages.1

Figure 1 shows that, with a price indexation formula, retiree benefits would have been cut substantially.  Under the current wage indexation, the Social Security benefit for a person with average earnings over one’s lifetime and retiring in 2005 would be $15,336 per year, replacing 42% of the average worker’s income.  If, however, price indexing had been used instead of wage indexing, that same 2005 retiree would receive only $6,180 per year, replacing just 17% of income.  In other words, as the figure shows, a change from wage indexation to price indexation would have meant a 60% cut in Social Security benefits for today’s retirees.

Figure 1

CRS also determined how this change would affect the elderly (people aged 65 and older) living in poverty in 2003.2  As shown in Figure 2, in 2003, 3.6 million elderly, or 10.2% of the noninstitutionalized elderly, lived in poverty.  If Social Security benefits had been calculated using price indexation, an additional 7 million elderly would currently be living in poverty, bringing the total to 10.5 million, or 30.4% of the elderly.3

Figure 2

A shift from wage indexing to price indexing may sound innocent, but would impose dramatic benefit cuts on retirees and, as a result, substantially increase poverty among the elderly.

This week’s Snapshot was written by EPI Deputy Director of Policy Amy Chasanov.

1. Congressional Research Service, Memo to Senate Finance Committee re: Estimated Effect of Price-Indexing Social Security Benefits on the Number of Americans 65 and Older in Poverty, January 28, 2005.  Though the use of wage indexing does not begin until later, it is instructive to understand the long-run effect of price indexation on benefits, since the president is proposing changes in benefit levels almost 40 years away.

2. The 2003 poverty threshold was $8,825 for an elderly individual and $11,133 for an elderly couple.  CRS used the March 2004 Current Population Survey to make these estimates.

3. CRS cautioned that workers and employers might have behaved differently if Social Security benefits were that much lower; however, they note that Social Security benefits are such a significant percent of retirees’ total income that any behavior changes would have been unlikely to fully offset these benefit cuts.  This is particularly true for lower-wage workers who would have had less opportunity to save for retirement.

See related work on Retirement

See more work by Amy Chasanov