Four Reasonable Social Security Reforms

With budget negotiations due to end December 13, House Budget Committee Chair Paul Ryan (R-WI) and Senate Budget Committee Chair Patty Murray (D-WA) would be wise to turn their eyes to the single largest spending item in the budget: Social Security.

Its $818 billion cost in 2013 is more than one-fifth of the entire federal budget.

Social Security trust fund reserves will be depleted in 2033 if no reforms are made. The task at hand is modifying the system and increasing public support for possible reforms. Here are four potential Social Security reforms, none of which must alter the program for current retirees:

Gradually Raise the Retirement Age. In 1983, the Reagan administration and the Democratic Congress reached a deal to gradually raise the retirement age beginning in the 2000s, with the final phased increase in the retirement age to 67 occurring in 2027. Benefits remain available at age 62, though they are significantly lower than the full benefits.

The success of their reform depended on providing workers ample time to adjust to changes. In doing so, reformers minimized opposition from both members of Congress and their constituents. Bipartisanship from those driving the reform ensured it would remain and not face threats of repeal from future administrations or Congresses.

Thirty years later, it is time to revisit this issue. Increases in life expectancy since Social Security’s inception were the rationale behind the 1983 reforms—a reasonable argument in the eyes of the public. According to the National Center for Health Statistics, when the 1983 adjustment was passed, life expectancy in the United States was 74.6 years. Life expectancy is more than four years higher today, and will be even higher in the future when reforms would take effect. The Congressional Budget Office (CBO) released a report estimating $58 billion in savings over ten years if the retirement age were raised to 67 faster than current law and then slowly raised by 2 months per year until age 70.

Allow Workers to Establish Voluntary Personal-Accounts. Early in his presidency, George W. Bush created a bipartisan Commission to Strengthen Social Security. Two of the three proposals from the commission made Social Security solvent over the long-term by offering personal retirement accounts to young workers. One of the commission’s most important findings was “Personal accounts can reduce the long-term cost growth of the Social Security system, thus contributing to fiscal sustainability.”  Every dollar invested into a personal account is a dollar, plus interest, saved by the government by reducing future Social Security payments.  According to Andrew Biggs, former principle deputy commissioner of the Social Security Administration and now a resident scholar at the American Enterprise Institute, “These personal account-based plans offered workers higher benefits at lower cost than the current program, while giving every worker the opportunity to build real assets and wealth.”

Under this plan, people could take a small proportion of their contributions and place it in an investment fund that meets certain criteria, such as diversification requirements. Various versions of this proposal take a centralized approach, in which the government provides investment options, or a decentralized approach, in which the 401(k) plans now offered by many large and medium-sized employers would be acceptable. Similar to Social Security as it is now, collecting benefits prior to retirement would be forbidden. However, one improvement would be making it possible for account holders to pass the account’s assets on to their heirs at death. Under current law, workers may pay into Social Security for years but have nothing to show for it if they die prior to retirement.

Opponents claim that establishing voluntary personal accounts is too risky and unreasonable. However, the true irrationality lies in forcing Americans—vulnerable or not—to pay into a system that will not yield returns on their retirement. Research published in the Federal Reserve Bank of St. Louis Review shows that “less than 5 percent of current retirees would receive a higher monthly benefit with Social Security” as opposed to investing in 6-month CDs or the S&P 500. Giving Americans the option to establish personal accounts is fair and would make progress towards establishing a solvent Social Security program.

Link initial benefits to average prices. A retiree’s initial benefits are determined by a formula averaging earnings over their lifetime. Every year, the initial benefits formula changes based on the growth of wages throughout the economy. Over time, wages grow faster than prices, so the real value of benefits has risen to an unprecedented amount since Social Security was first established.

Determining initial benefits based on average prices would end this excessive spending growth over the coming decades. Average prices would be determined by change in the consumer price index for all urban consumers. Linking benefits to average prices instead of wages ensures that all retirees get enough benefits to meet their needs while making the project more sustainable for the future. 

The CBO concluded that implementing this reform could save $93.4 billion over ten years under the pure price indexing described above. An alternative proposal, called progressive price indexing, would retain the current benefit formula for low income workers but only save $57.5 billion over ten years. Their calculations are made assuming changes would take effect in 2015, but more reform would likely need to delay implementation for a decade to remain politically feasible.

Improve the Accuracy of the Cost-Of-Living Adjustment. Under current law, cost-of-living adjustments to Social Security benefits are based on the Consumer Price Index. The BLS calculates the CPI based on overall inflation, but they also calculate a more accurate measure called chained CPI.

The chained CPI is a better measure of inflation for two reasons. First, traditional CPI does not account for someone’s natural response to a price change. When the price of one product rises, but its competing product’s price remains the same, consumers naturally buy the cheaper product. However, traditional CPI overstates inflation by measuring the rise in price of the initial product, whereas chained CPI remains steady by acknowledging customer response to the price change. Second, the traditional CPI suffers from small sample size bias, whereas the BLS uses a different calculation for chained CPI.

As a result, the chained CPI is a better indicator of surges in the cost-of-living. Since traditional CPI overstates inflation hikes, using chained CPI to calculate cost-of-living adjustments would not only be more accurate, but save money. CBO calculations show that using the chained CPI to calculate adjustments for Social Security benefits could save $107.8 billion over 10 years.

The cost-savings of adopting the chained-CPI are recognized not only by those on the right, but by the Obama administration as well. In his FY2014 budget, President Obama included adoption of a chained-CPI with a pair of conditions for Congressional Republicans. Despite those conditions, the fact the President was willing to include it at all shows how reasonable the chained-CPI is and how close it is to adoption.

This proposal, and those preceding it, would go a long way in ensuring the long-term solvency of Social Security so that drastic, arbitrary benefit cuts and tax hikes are not required in the future. Trimming entitlement spending using these reasonable reforms would be a step in the right direction and enhance the long-term economic and budgetary health of the country for the next half-century.

Jason Russell is a research associate at the Manhattan Institute for Policy Research. You can follow him on Twitter here.