In negotiations with congressional leaders over how to avoid a default on government debt, President Obama has proposed changing the way Social Security and other benefits are indexed for inflation as part of a deal to reduce future budget deficits.
The overall reduction in deficits would be more than $200 billion over 10 years, not counting additional savings from lower interest payments on the government’s reduced debt. That total would include $112 billion less in Social Security cost-of-living increases in over the next decade, according to the Congressional Budget Office. If applied to federal civilian and military pensions and veterans’ benefits, it would reduce spending by another $24 billion. If indexing of income tax brackets were included, tax revenues would rise by $72 billion over the decade, CBO estimates.
But while moving to a so-called chained consumer price index would cut costs, it won’t be an easy sell. Although some say it would more accurately adjust benefits for increases in the cost of living, others worry that it would reduce benefits for those who need them most.
“I am conflicted, to tell the truth,” Robert Reischauer, president of the Urban Institute and a former CBO director, said in an interview. “This is an index that hopefully would be used for all programs that are indexed and for the tax code. What one is looking for is the best all-purpose index for inflation, and this is certainly better than what is being used now.”
But he noted that the effect of smaller COLAs over time would hit much older beneficiaries harder and when other assets, such as a private pension that is not indexed for inflation, are falling in value. Still, he said, “if I were forced to come up with a package to secure Social Security for the long run, I would probably include this proposal.”
Federal benefits and tax brackets currently are indexed to changes in one of two versions of the consumer price index. Social Security benefits are tied to changes in the cost of a market basket of goods and services bought by urban wage earners and clerical workers—the CPI-W. Federal pensions, other benefits and the tax brackets are indexed to a different market basket bought by all urban residents—the CPI-U.
The burst of inflation caused by surging food and gasoline prices this year means that next January, Social Security beneficiaries and federal retirees likely will see their first cost-of-living adjustment in three years, probably in the neighborhood of 3.5 percent, based on May data, possibly more. The actual amount will be announced in October, based on the change in the CPI-W from the third quarter of 2010 to the third quarter of this year.
The Bureau of Labor Statistics is set to announce the June CPI on Friday. But the 211 categories of items in the market baskets are updated only every two years and don’t quickly reflect consumer responses when the cost of some items goes up faster than possible substitutes. Nearly a decade ago, the Bureau of Labor Statistics began publishing the chained CPI, an experimental version of the CPI that takes account of such substitutions. The chained CPI-U usually rises about three-tenths of a percentage point less annually than the regular CPI-U.
“What is certain is that the switch would lower benefits,” said economist Dean Baker of the Center for Economic and Policy Research, a liberal think tank. If COLAs are lower by roughly 0.3 percentage points a year, he notes, “after someone has been retired for 10 years, their benefits would be 3 percent lower. After 20 years of retirement, their benefits would be 6 percent lower and people living into their 90s and collecting benefits for more than 30 years would see a drop in benefits of more than 9 percent.”
Baker said changing the COLAs would affect current retirees, more than 90 percent of whom have non-Social Security incomes of less than $40,000. And he added that Congress’ Joint Committee on Taxation “recently estimated that by 2021, 69 percent of the higher tax revenue gained from switching to the chained CPI would come from taxpayers making less than $100,000.”
A huge surge in gasoline prices in 2008 led to a whopping 5.8 percent cost of living adjustment for Social Security recipients in January 2009. But gasoline prices tumbled again and when the price index stayed below the 2008 high in the third quarters of 2009 and 2010, no COLA was paid last year or this.
Had the chained CPI been in use in 2007 and 2008, the 2009 COLA would have been much smaller--4.6 percent instead of the actual 5.8 percent. Part of the difference is that the chained CPI—unlike other versions of the index—is revised twice as more information becomes available about how consumers changed their purchases in response to some prices rising faster than others.
As the president acknowledged in his press conference Monday, “We’re going to have a sales job; this is not pleasant. It is hard to persuade people to do hard stuff that entails trimming benefits and increasing revenues. But the reason we’ve got a problem right now is people keep on avoiding hard things, and I think now is the time for us to go ahead and take it on.”
More from The Fiscal Times about Social Security:
Obama Ups the Ante with Social Security and Medicare Cuts
Three Things You Can’t Say about Social Security
AARP Open to Discussing Social Security Changes