No to Progressive Indexing

Here is the grand strategy at the White House on Social Security: Propose a cut in future promised Social Security benefits for the middle class as well as for upper income workers. That will lead enough Democrats to support personal accounts to enable the entire plan to pass.

I know that sounds preposterous. That is because it is. But that has been the misbegotten “strategic thinking” at the White House for a long time now.

So in his press conference last week the President proposed benefit cuts for middle-class and upper-income workers through “progressive price indexing,” an idea suggested by Democratic Massachusetts mutual fund executive Robert Pozen. Here is how that works.

Declining Returns

Under current law, while a worker is working, the future benefits he is to receive from Social Security increase at the rate of growth of wages in the economy each year. Under progressive price indexing, this remains the same for workers earning less than $25,000 per year, so there is no cut in future benefits for them. But for workers earning over $113,000 per year, their future benefits would grow only at the rate of growth of prices. For workers earning between $25,000 and $113,000 each year, their future benefits would grow at a rate between wages and prices, shifting more towards prices the higher the worker’s income grows.

In other words, future promised benefits would be cut for workers earning over $25,000 per year, with benefits cut more the higher the worker’s income. According to the Social Security Administration’s analysis of the Pozen Plan a worker making $36,507 would see his benefit drop by 6% by 2025, 16% by 2045, and 28% by 2075.

A key additional factor is that Social Security taxes assessed through the payroll tax grow with wages over time. If benefits grow more slowly than wages, as they would under this proposal for everyone earning over $25,000 per year, the rate of return paid by Social Security for these workers would decline every year in perpetuity as taxes would grow faster than benefits each year.

The rate of return promised by Social Security under the current wage-indexed system is already well below market returns. Under the above price-indexing system, all workers earning over $25,000 per year would eventually be pushed down into a negative real rate of return, with the return becoming more negative each year. This makes the current problems with Social Security worse, not better.

In addition, workers’ incomes grow each year. If benefits grow more slowly than wages, then the replacement rate, or percent of pre-retirement income paid by Social Security, would decline each and every year in perpetuity as well.

Currently, Social Security replaces about 40% of pre-retirement income, and with wage indexing that would remain stable over time. But under progressive price indexing, that would slowly be reduced year after year for all workers earning over $25,000 per year, until only 20% of pre-retirement income is replaced, then 10%, then eventually 5%, etc.

How is proposing this plan going to move Democrats to support real personal accounts, with the accounts substituting for the current Social Security system over time? It won’t. Quite to the contrary, as reported in the Wall Street Journal on May 4, “In both chambers, Democratic lawmakers insist Mr. Bush has strengthened their position by embracing an approach that would reduce promised Social Security benefits for seven in 10 Social Security recipients. ‘There is no seat that Democrats are going to lose because we stand up for the principle of guaranteed benefits,’ says Rahm Emanuel of Illinois, who is chairman of the party’s campaign committee.”

Rather than leading to personal accounts, this proposal is going to lead, at most, only to a tax increase and no real personal accounts–or to no reform at all. The Democrats will never accept a plan that tries to eliminate the Social Security deficit solely through future benefit cuts. They will insist the plan has to include a balance of tax increases and benefit cuts. Moreover, the Democrats have already insisted they will not support any plan with real personal accounts that substitute for part of the current system. So they will insist on dropping those accounts as the price for their support for any package of tax increases and benefit cuts.

This is already playing out. The Wall Street Journal also reported on May 4 that “Senate Republicans are considering seeking passage of a Social Security bill that abandons private accounts in favor of simply shoring up the program’s long term solvency through approaches such as the one Mr. Bush has embraced.” On May 2, Robert Pozen, author of the progressive price-indexing plan, proposed in a Wall Street Journal op-ed a compromise with Democrats. It would include his proposal for progressive price indexing, plus a tax increase adding a surcharge of 2.9% of wage income for all workers earning over $90,000 a year, with the opportunity to put some of that money in an add-on account on top of Social Security.

More likely, with the reform effort lost in the swamps of benefit cuts and tax increases, nothing will pass at all. Democrats will then campaign next year arguing that they saved the middle class from draconian future benefit cuts and that the whole episode shows why more Democrats are needed in Congress to save the country from these crazy Republican plans.

In 1985, the Republican Senate passed a modest adjustment of the Social Security COLA, which never passed the House. In 1986, Democrat challengers ran ad after ad against Republican senators who had voted for the COLA change. The Republicans lost eight Senate seats and majority control. Progressive price indexing is a thousand times more severe than the COLA adjustment the Senate passed in 1985.

So the White House’s confused Social Security strategy threatens the Republican majorities in Congress. If those are lost, that will devastate conservatives across the board on issue after issue, from abortion to gun control to taxes to national defense.

Moreover, this confused strategy is fumbling away President Bush’s incredibly brave support for personal accounts through two successful elections. Ideologically, personal accounts are the jackpot for conservatives, for they hold the potential for the greatest reduction in taxes and government spending in world history through shifting responsibility for financing and paying retirement benefits from government to the capital markets. A frontal assault trying to cut future promised benefits could never accomplish nearly as much, and would probably, as discussed, backfire.


Instead of this folly, a promising alternative would be to use the short-term Social Security surpluses to finance as large a proportion as possible of the 6.4-point personal accounts proposed by Rep. Paul Ryan (R.-Wis.) and Sen. John Sununu (R.-N.H.)–with no tax increases or benefit cuts. This could be backed with the highly popular theme of stopping the raid on the Social Security trust fund to finance other government spending. Later, we could then advocate expanding the accounts to the full Ryan-Sununu level, which would both achieve permanent solvency for Social Security and provide workers with a much better deal than the current system.

Republicans have already run in dozens of races with the issue framed as the Ryan-Sununu proposal frames it, and they have won every single one. This approach allows us to focus on the populist positives of personal accounts, which have been lost in the fog of numerous highly unpopular benefit-cut and tax-increase ideas. Personal accounts are controversial enough as it is. The idea can’t be burdened with tax increases and benefit cuts.

If the White House would change course and just dance with what brung em, glorious victory can still be snared from the jaws of defeat.