The congressional “super committee” has only a few days left to reach a deal on trimming the nation’s debt trajectory. If they reach a deal, and let’s hope for the sake of the economy they do, it will probably include some trimming of future Social Security benefits by changing the way benefits are calculated.
If the Social Security benefit calculation is changed, it will likely be in the form of the way benefits are indexed for inflation. In past discussions of Social Security reform, there have been two distinctly different proposed changes to indexing. The more drastic is a change in the way a person’s lifetime earnings are indexed (Washington Post, “Social Security Formula Weighed,” January 4, 2005).
Less drastic is a change in the way the monthly benefit once initially determined, is changed to keep up with price inflation by using a chain weighted consumer price index. By all reports thus far, it is this more modest change in indexing being considered by the super committee.
Let’s use and example to highlight the effects of these distinctly different proposals.
In 1964 Maria got her first real job. That year she earned $4,576. Her wages gradually increased over her working life, until she reached the full retirement age of 65 in 2004. She earned $34,731 in her last year of work. So what was Maria’s benefit when she retired?
To calculate her benefits, Social Security took the 35 years of Maria’s work life in which her earnings were highest. Then they adjusted them by the general rise in average wages.
Data show that average annual wages in the United Statesin 2003 were 7.27 times higher than they were in 1964. So Maria’s 1964 wages were multiplied by 7.27 to make them comparable to current wage levels. In each year of her work history, Maria’s earnings were adjusted in this way to the general rise in wages to keep them on a par with the living standards earned by current workers.
Then for the 35 years in which Maria’s adjusted wages were highest, they were summed up and divided by 420, the number of months in 35 years. This calculation amounts to $2,774.
Maria’s monthly Social Security benefit was then determined by the following formula:
(.9 X $627) + .32 X ($2744 – $627) = $1,251
Since Maria started receiving her monthly benefits in 2004, they have been adjusted upwards each year by the Consumer Price Index, so that her monthly benefit would now be about $1,350.
How would Maria’s benefit look if her wage history had been indexed to prices rather than to the rise in wages?
I’ve done the calculations. Her initial monthly Social Security benefit would have been $1,127 per month if all her wages had been adjusted by price changes rather than by wage changes. That’s a 9.9 percent cut in her benefits.
Thus far the super committee hasn’t been considering a change from wage indexing to price indexing of wage histories, at least not from public reports, so at the moment such large cuts in benefits are not on the horizon.
Instead the committee has been considering a modest change in the way benefits, once initially determined, are adjusted for future inflation. It would be a switch from the use of the CPI to something called the chain-CPI. The chain CPI takes into account that consumers will change what they buy, as prices of various goods and services change, buying less of what has become more expensive and more of less pricey items. This would lower the measured increase in prices by about 0.3 percentage points per year on average.
If Maria’s monthly benefit since 2004 had been adjusted by the chain-CPI her current benefit would be about $1,322 as opposed to the $1,350 under the current method for adjusting for inflation, a more modest cut than the change to wage indexing would produce.
I can’t speak for Maria, but I think we could all live with that, if it would help lead us to a super committee deal to lower the trajectory of future U.S.budget deficits.
A caveat should be added to all of this. Nobody has proposed cutting benefits of current Social Security payments to recipients like Maria. Rather, any proposal to cut benefits would only apply to future benefit increases. And any changes to the benefit formula, if any were to be proposed, would only apply to future retirees and most likely only to workers under a specified age, so there would be time for them to take into account the changes in future benefits and to adjust their plans accordingly.