TRILLION HERE, A TRILLION THERE:

Social Security Formula Weighed: Bush Plan Likely to Cut Initial Benefits (Jonathan Weisman and Mike Allen, January 4, 2005, Washington Post)

The Bush administration has signaled that it will propose changing the formula that sets initial Social Security benefit levels, cutting promised benefits by nearly a third in the coming decades, according to several Republicans close to the White House.

Under the proposal, the first-year benefits for retirees would be calculated using inflation rates rather than the rise in wages over a worker's lifetime. Because wages tend to rise considerably faster than inflation, the new formula would stunt the growth of benefits, slowly at first but more quickly by the middle of the century. The White House hopes that some, if not all, of those benefit cuts would be made up by gains in newly created personal investment accounts that would harness returns on stocks and bonds.

But by embracing "price indexing," the president would for the first time detail the painful costs involved in closing the gap between the Social Security benefits promised to future retirees and the taxes available to fund them. In late February or March, the administration plans to produce its proposed overhaul of the system, including creation of personal investment accounts and the new benefit calculation.

"This is going to be very much like sticking your hand in a wasp nest," said David C. John, a Social Security analyst at the conservative Heritage Foundation and an ally of the president. "And the reaction will be similar."

In informal briefings on Capitol Hill, White House aides have told lawmakers and aides that Bush will propose the change in the benefits formula, an approach recommended by his 2001 Commission to Strengthen Social Security , according to congressional aides and lobbyists.

Currently, initial benefits are set by a complex formula that calculates workers' average annual earnings in their 35 highest-paid years and adjusts those earnings up from those years to reflect standards of living near that worker's retirement age. That adjustment is based on wage growth over that time span. Under the commission plan, the adjustment would be based instead on the rise of consumer prices.

The change would save trillions of dollars in scheduled expenditures and solve Social Security's long-term deficit, but at a cost.

No one expects to get their money back anymore. Give them private accounts where they can recoup the money and it's a deal.

MORE:
The Trillion-Dollar Question (William Sterling, 12/29/04, Tech Central Station)

If President Bush pushes ahead with his proposal to privatize some portion of Social Security, politicians will almost certainly be forced to engage in a heated debate about a fairly obscure and technical topic: should Social Security's initial benefits be tied to future changes in consumer prices or wages?

This sounds like an issue that would matter only to economic policy wonks. But literally trillions of dollars are at stake in resolving the issue so a spirited debate is warranted. Following a controversial act of Congress in 1977, the current system has generously tied future benefits to changes in overall wages. In contrast, The President's Commission to Strengthen Social Security proposes to tie future benefits to the consumer price index. It would use the substantial cost savings to assure the solvency of the system and to improve poverty protection for the lowest-income workers beyond what is provided by the current system.

Wage indexation of benefits is naturally more expensive to the government than price indexation because wages tend to rise more rapidly than prices over time. An ongoing rise in real wages is a welcome consequence of overall growth in productivity. If firms are able to produce more widgets per hour thanks to new technologies or better business processes, they can afford to pay more to workers and still earn healthy profits. The most widely accepted models of economic growth, which will be considered shortly, suggest that the observed link between real wage growth and productivity is far from accidental.

Price indexation should save the government trillions of dollars in the long run because of the magic of compound interest. Wage growth has historically outpaced consumer price inflation by about 1.1% per annum. That means that the real value of wage-indexed benefits will be twice as high as price-indexed benefits after 70 years. And that is why a seemingly modest technical change in the benefits formula is a potential "magic bullet" for putting Social Security on a sound financial footing.

Posted by Orrin Judd at January 4, 2005 1:33 PM