Options for Reducing the Social Security Shortfall

Modifying Benefit Formula

The current benefit formula uses the highest thirty five years of subject salary) which are adjusted by average wage growth (the earlier the year, the more upwards thje adjustment). The resulting figure is then credited in three stages, with the lowest portion of the salary given the heaviest weight in order to provide those with the lower incomes the greatest percentage of their pre-retirement income./1/ Two changes are receiving serious consideration:

1. Changing the indexing computation for the Average Indexed Monthly Earnings (AIME) from wage indexed to inflation indexed, and/or

2. Adjusting the percentages (and/or changing the formula to determine the dollar amounts) of the bend points in the formula that coverts the AIME to the actual Primary Insurance Amounts (i.e., monthly benefit at Normal Retiremant Age)

Changing the adjustment factor for older wages

Currently, older wages are indexed upwards to reflect average wage growth. The factor could be changed to use the Cost of Living Adjustment, instead of the average rise in wages. Because average wages tend to rise faster than the Cost of Living, this change would produce significant savings.

Arguments For

First, wage-based indexing is unaffordable and the single greatest drain on fund benefits.

Second, indexing by wages means that two individual who earn exactly the same real (COLA-adjusted) wages but are some years apart in age will get different benefits after retirement, making wage-indexing not only unaffordable, but unfair./2/

Arguments Against

Social Security currently works to maintain some portion of an individual's standard of living after retriement. Because, historically, wage growth has exceeded inflation, workers' standard of living has risen. Using the COLA instead of the wage index would significantly reduce Social Security's contribution to maintaining that standard of living in retirement. The low wage earner, instead of seeing slightly over half of the income (56%) needed to maintain his standard of living would, by 2075, see that reduced to less than one third (31%) of his pre-retirement income. Reverting to the inflation adjusted calculation means that the individual's retirement benefits will be maintaining a standard of living perhaps half way though his working career.

Savings

Because the effect is felt gradually, the impact on specific retirees varies. A middle income wage earner retiring in 2022 would see a 9.9% reduction in benefits, but by 2075 that reduction would be 54% (approximately almost twice the projected shortfall.)/3/

Such a change would would, conswervatively, reduce the shortfall by 70%.

Footnotes

1. See the Social Security Administration's Social Security Benefit Amounts for more complete description.

2. See, for example, the Cato Institutes's "Susan Lee: Time to Change the Wage Indexed Benefit Scheme" (Since we are discussing the arguments offered by advocates of various positions, the citation is offered to support the advocacy, not the veracity of some of the comments.)

3. Based on figures supplies by the Chief Actuary of the Social Security Administration, cited in Washington Post, Jan 4, 2005, http://www.washingtonpost.com/wp-dyn/articles/A45726-2005Jan3.html, viewed Jan 4, 2005 at 7:51 AM, EDT