Chained CPI and Social Security: Some Questions and Answers

Back in January I said I’d delve into the impacts of using the chained CPI (Consumer Price Index) to adjust Social Security benefits.

Then the President delivered a strong defense of “the commitments we make to each other,” including Social Security. So I put my draft post aside, figuring the chained CPI was off the bargaining table.

The more fool I. As you’ve probably read, it’s among the entitlement “reforms” in the President’s proposed budget.

The White House has taken great care to package it with other changes that would supposedly protect very elderly retirees and others who’ve relied on Social Security benefits for a long time. Also to shield programs that base eligibility on income.

But as economist/blogger Jared Bernstein said some time ago, the danger is that protections like these will all get swept aside, leaving only the benefits cuts.

Here then are some of the basic issues, as I see them. More to follow in a second post.

Why Do Anything About Social Security?

Our federal policymakers must do something about the Social Security retirement and disability insurance programs — and the sooner the better.

The Trust Fund will run out of money long about 2033. If nothing is done before then, the Social Security Administration will have to rely solely on what it continuously receives from payroll taxes.

That would be enough to pay about 75% of the benefits retirees would get if the Trust Fund still had reserves — a devastating loss for the nearly two-thirds who rely mainly or entirely on those benefits.

What Could Prevent the Shortfall?

At the risk of over-simplifying, our policymakers have two choices, not counting just letting the Trust Fund dry up. They could change the system to take in more or pay out less.

A switch to the chained CPI represents the latter approach because it rises more slowly than the currently-used index — the CPI-W. So, therefore, would the benefits that seniors, severely disabled former workers and eligible survivors receive.

Policymakers could instead “scrap the cap” on the amount of wage income subject to the tax that feeds the Social Security programs.

Or they could raise it enough to cover all but the top 10% of income, as it did in 1982 after Congress stepped in to shore up the program — not for the last time, incidentally.

High earners wouldn’t like this, of course. Nor perhaps would employers, since they’re responsible for half the payroll tax.

The National Federation of Independent Business has already said that its small business members “would violently oppose” it. These, as you know, are the “job creators” that our President and Congressional leaders are so fond of.

Is the Chained CPI More Accurate for Cost-of-Living Adjustments

Proponents of the chained CPI claim that it’s simply a more accurate cost-of-living measure because it reflects consumer responses to price increases. If the price of beef goes up, they buy less of it and more chicken. Etc.

Opponents argue that the index isn’t more accurate for seniors because they spend far higher portions of their income on items that aren’t amenable to switches, especially health care.

Even the CPI-W apparently understates their cost-of-living increases.

For some time now, the Bureau of Labor Statistics has maintained an experimental cost-of-living index specifically for the elderly. Over the long haul, it has risen somewhat faster than the CPI-W. And Social Security’s chief actuary expects it will in the future.

We’d probably see similar results from a cost-of-living measure for people with severe disabilities, since many of them also have disproportionately high health care costs.

So if accuracy were the real issue, Congress would give BLS the funds to fully develop its experimental index, as The New York Times, among others, has suggested.

What Other Objections Have Opponents Raised?

The over-riding objection to the chained CPI switch is that it would effectively cut benefits. The loss in any one year would be small. But losses would mount up over time because the base for each cost-of-living adjustment, as well as the COLA itself, would be lower.

The average earner, says the Strengthen Social Security Campaign, would lose a total of $4,631 by age 75 — more than three months of benefits. Another 10 years and the loss would mount to nearly a year’s worth of benefits.

We need to recall that retired workers now get, on average, only $1,261 a month — and former workers in the Social Security Disability Insurance program somewhat less.

For 36% of seniors, Social Security provides at least 90% of income — not surprising, given what we know about retirement savings. It’s the sole source of income for 29% of the most elderly.

As I mentioned earlier, the President’s budget includes a “benefit enhancement” — popularly known as a bump up. It’s supposed to restore the cumulative losses for people who live long enough to benefit.

Most who do would still get less, according to the SSS Campaign.

Those who don’t are just out of luck, of course. And they’re disproportionately lower-income people, for whom every Social Security dollar counts.

UPDATE: After I published this, the Center on Budget and Policy Priorities issued a brief that provides more detail on the impacts of the chained CPI on Social Security retirement benefits.

We Can Shore Up Social Security Without Harming Seniors

Every year for quite awhile now, the annual Social Security Trustees’ report evokes alarmist headlines.

“Social Security Still Going Broke (Again),” trumpets the National Taxpayers Union. Politico columnist John Goodman chimes in with “Social Security trustees: We’re going broke.”

And every year experts — and responsible news media too — explain that the Trust Fund isn’t going broke at all.

What with payroll taxes coming in, plus interest on the reserves invested in Treasury bonds, the Fund is now expected to have enough to pay full retirement benefits until 2033.

After that, it will still have enough to pay three-quarters of what retirees should get under current law until 2086.

This year’s report nevertheless projects a shortfall three years sooner than last year’s. Trustees blame the economy — specifically, lower real earnings due to the energy price spike and sluggish growth in average hours worked.

Republicans don’t fret such nuances. They blame the President for not reforming entitlement programs — as if this is something he could do without their votes in Congress.

Well, there are apparently proposals they’d be willing to support — unless they came from the White House, of course.

Back in 2010, House Majority Leader John Boehner teed up the idea of raising the retirement age again. Several leading House Democrats seemed willing to consider this, though it’s doubtful they’d stick their necks out now.

Three Republican Senators introduced an additional wrinkle last year. Once the retirement age gets to 70, index it to life expectancy — presumably in expectation that the average life span will continue to increase.

Average life span, note, not the life expectancy for low-income people. Overall life expectancy gains have masked significant — and growing — differences between richer and poorer Americans.*

The Senators also proposed changing the benefits formula so that “high earners” — those with average annual earnings of a mere $43,000 a year — would get less than they would under current law.

Presidential hopeful Mitt Romney apparently has something similar in mind — for both the age increase and the curbed benefits growth for those “with higher incomes.” Needless to say, no details here.

The modified means test is one of several schemes for reducing Social Security pay-outs.

One that’s gotten more play across the political spectrum would adopt a different cost-of-living adjustment index.

The COLA is now linked to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) — a measure based on the costs of a standardized market basket of goods and services typically purchased by households in the groups named.

Economists of diverse political leanings have suggested switching to the so-called chained (or chain-weighted) Consumer Price Index.

The co-chairs of the President’s deficit reduction commission liked this idea. So did both the concurrent Bipartisan Policy Center Task Force and the Gang of Six Congress members who later thrashed out an abortive plan to end the debt ceiling standoff.

The chained CPI attempts to reflect consumers’ behavior in response to prices as well as prices themselves — specifically the fact that people change their buying habits when prices rise. When beef prices increase, they buy less steak and more chicken, etc.

A switch to this CPI would thus slow benefits growth. But would it accurately reflect retirees’ living costs? Apparently not.

The Bureau of Labor Statistics has been maintaining an experimental CPI for elderly Americans for about 30 years now. It’s found that the index rises somewhat faster than the CPI-W, mainly because seniors spend a greater share of their budgets on health care, housing and, to a lesser extent, heating oil.

The average gap between the indexes isn’t great for any one year, but it mounts up over time. Switch to an index that rises more slowly than the CPI-W and the gap between living costs and benefits increases.

So we’ve got objections to this, objections to that. Yet everyone agrees that Social Security needs some sort of fix. And the sooner it’s made, the less drastic it will have to be.

There’s another obvious fix. Scrap the cap, as it’s commonly referred to. In other words, subject all earnings to the payroll tax rather than give a free pass to everything over a fixed amount.

The cap is adjusted annually, using yet another CPI, but nothing’s been done since 1983 to capture the increasing amount of income flowing to a relatively small number of high-earners.

As a result, the tax has become more regressive. And the Trust Fund is losing revenues that could help it stay solvent — perhaps for 75 years, the Strengthen Social Security coalition says.

Scrapping the cap alone won’t solve the problem, however.

If that’s all that’s done, then the extra revenues gained would ultimately get paid out in higher benefits because, at this point, benefits are based partly on lifetime income subject to the payroll tax.

But one could adjust the formula so that contributions above the current cap didn’t count toward benefits — or did, but only partially, as Congressman Ted Deutsch (D-FL) has proposed.

Seems to me a whole lot fairer to lift the cap than to force people in their late 60s to continue working — or fall into poverty because they can’t get work if they lose their jobs.

Also fairer than reducing benefits across-the-board when we know — or ought to — that a large majority of seniors would be hard put to pay for basic living costs, as about one in six are even now.

* A recent brief by the Economic Policy Institute addresses in detail other arguments against raising the retirement age. Heavily sourced for those who want to plunge in even further.