In a previous post, I cited a CBO report which stated that the federal government could save $127 billion over the next decade if the Social Security Administration (SSA) used a chain-weighted consumer price index (CPI) to adjust retiree’s payments to increases in cost-of-living. Current policy uses a non-weighted CPI to measure the rate of inflation—which the report says overstates inflation by 0.25 percentage points a year.
A little over a year ago I wrote a paper which suggested a somewhat related reform to the way the federal government handles the cost-of-living-adjustment (COLA) to Social Security payments. Instead of implementing COLAs on an annual basis, the SSA should adjust payments when the price index increased by five percent. The following is the abstract from the paper:
The most recent Social Security Trustee Report projects an Old Age Survivors Disability Insurance (OASDI) shortfall of $16.1 trillion in present value terms over an infinite time horizon. Politicians have divergent opinions on how to address this looming crisis. Some advocate higher payroll taxes, others propose reductions in benefits. Still others believe there isn’t a problem since there is money in the Trust Fund to cover outlays until 2037. One aspect looked at in the past has been with the way the government adjusts benefits to rises in cost-of-living. The current methodology uses annual changes in the Consumer Price Index (CPI) to adjust retiree’s benefits. Some economists argue the CPI overstates the impact of inflation, which means benefits have increased well above the rate of inflation—putting the system under additional financial strain. Even if a consensus believed this true, the creation of a new index would be a costly and time-consuming endeavor. This paper presents an alternative way to administer COLAs, which could over the ensuing decades, provide trillions of dollars in savings relative to the present methodology. Instead of adjusting retiree benefits every January based on the annual rise in the CPI, the proposal is to adjust benefits when the CPI has increased by five percent—however long it takes. If the rate of inflation is below five percent per annum, it would save the government money. In addition, it would not entail any revision to the methodology used to calculate the CPI; nor should it induce large hardships on those who currently receive benefits. The author does not suggest that this recommendation would alone solve the fiscal crisis facing Social Security. Rather, it is a political viable way to create some budgetary savings while political forces come together to create a more sustainable solution.
Many, like The Washington Post’s Ezra Klein oppose using the chain-weighted CPI. He writes: “The only reason we’re considering moving to chained-CPI because it saves money, and it saves money by cutting Social Security benefits and raising taxes, and it’s a much more regressive approach to cutting Social Security benefits and raising taxes than some of the other options on the table.”
The purpose of COLAs is to adjust Social Security benefits so as to maintain a constant purchasing power. So why is it wrong to introduce an improved measurement of the true rate of inflation? Should it not be the goal to be as accurate as possible? Besides, no one’s benefits are being cut—only the size of future increases is impacted. If the studies are true, that the non-weighted CPI overstates inflation, then seniors have been receiving real increases in payments for decades, adding additional budgetary strain to the system.
Now I admit a major reason for my proposal was to offer a way to create some budgetary savings with as little pain as possible. Yet adopting my proposal would better reflect the true reason for COLAs—the maintaining of a constant purchasing power. For instance, under current policy, if the economy experiences deflation (as it did a couple of years ago) benefits are not decreased. This results in a real increase in benefits, which gets embedded into future cost-of-living increases. This doesn’t happen in my proposal.
A second benefit has to do with economic signaling. Classical economics describes how the economy, through changes in prices, moves to an equilibrium output. When there are changes in supply and/or demand, prices adjust to induce consumers to modify their behavior to restore equilibrium. For instance, if the price of gasoline rises, in the short-run people may consume the same amount and purchase less of something else like eating out. Over a period of time they may do any number of things: buy a more fuel-efficient car; move closer to work; get a job closer to where they live; or join a carpool. When the government gives predictable raises in benefits, it discourages people from making adjustments to their economic behavior.
In an ideal world we could provide seniors with real benefit increases every year. The problem is we don’t live in such a place. Yet since the adoption of COLAs to Social Security benefits in the early 1970s, we have in essence been doing just that.
At some point Congress and the president will need to do something to reform Social Security. According to the latest SSA Trustee Report the present value of the unfunded obligations (over an unlimited time horizon) is now at $20.5 trillion—up from $17.9 trillion projected in the previous year’s report.
The Trustees write: we “recommend that lawmakers address the projected trust fund shortfalls in a timely way in order to phase in necessary changes and give workers and beneficiaries time to adjust to them. Implementing changes soon would allow more generations to share in the needed revenue increases or reductions in scheduled benefits.”
Using a chain-weighted CPI and implementing my suggestion will not alone bridge the gap in the expected long-term deficits in Social Security. That requires making decisions on such things as raising the retirement age, increasing payroll taxes and/or modifying the benefit formula used to calculate initial monthly benefits. Instead, the intention is to provide some real savings to the system in order to allow politicians to gradually incorporate the necessary reforms. In the end, how to save Social Security is not an economic effort but rather a political one.