Function 650 - Social Security
Link Initial Social Security Benefits to Average Prices Instead of Average Earnings
CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.
|Billions of Dollars||2017||2018||2019||2020||2021||2022||2023||2024||2025||2026||2017-2021||2017-2026|
|Change in Outlays|
|Pure price indexing||0||*||-1||-3||-6||-9||-14||-20||-26||-34||-11||-114|
|Progressive price indexing||0||*||-1||-2||-4||-6||-9||-12||-17||-22||-7||-72|
This option would take effect in January 2018.
* = between –$500 million and zero.
Social Security benefits for retired and disabled workers are based on their average lifetime earnings. The Social Security Administration uses a statutory formula to compute a worker’s initial benefits, and through a process known as wage indexing, the benefit calculation in each year accounts for economywide growth of wages. Average initial benefits for Social Security recipients therefore tend to grow at the same rate as do average wages, and such benefits replace a roughly constant portion of wages. (After people become eligible for benefits, their monthly benefits are adjusted annually to account for increases in the cost of living but not for further increases in average wages.)
One approach to constrain the growth of Social Security benefits would be to change the computation of initial benefits so that the real (inflation-adjusted) value of average initial benefits did not rise. That approach, often called “pure” price indexing, would allow increases in average real wages to result in higher real Social Security payroll taxes but not in higher real benefits. Beginning with participants who became eligible for benefits in 2018, pure price indexing would link the growth of initial benefits to the growth of prices (as measured by changes in the consumer price index for all urban consumers) rather than to the growth of average wages. (That link would operate through reducing three factors that determine the primary insurance amount. The factors would be reduced by the real wage growth in each year. Those three factors are now 90 percent, 32 percent, and 15 percent; the earnings amounts at which the factors change are called bend points. For example, with real wage growth of 1 percent, the three factors would be reduced by 1 percent, so in 2018 they would be 89.1 percent, 31.68 percent, and 14.85 percent, respectively.)
Pure price indexing would reduce federal outlays by $114 billion through 2026, the Congressional Budget Office estimates. By 2046, scheduled Social Security outlays would be reduced by 16 percent from what would occur under current law; when measured as a percentage of total economic output, the reduction would be 1 percentage point because outlays would decline from 6.3 percent to 5.3 percent of gross domestic product. People newly eligible for benefits in 2046, CBO estimates, would experience a reduction in benefits of about one-third from the benefits scheduled under current law.
Under pure price indexing, each cohort of beneficiaries would receive successively smaller benefit payments than those scheduled to be paid under current law; the growth of average real wages would determine the extent of the reduction. For example, if real wages grew by 1 percent annually, workers newly eligible for benefits in the first year the policy was in effect would receive 1 percent less than they would have received under the current rules; those becoming eligible in the second year would receive about 2 percent less; and so on. The actual incremental reduction would vary from year to year, depending on the growth of real earnings.
Another approach to constrain the growth of initial Social Security benefits, called progressive price indexing, would keep the current benefit formula for workers who had lower earnings and would reduce the growth of initial benefits for workers who had higher earnings. (That approach would be implemented by adding a new bend point and reducing the factors that determine the primary insurance amount above that bend point.) The present formula for calculating initial benefits is structured so that workers with higher earnings receive higher benefits, but the benefits paid to workers with lower earnings replace a larger share of their earnings.
Under progressive price indexing, initial benefits for the 30 percent of workers with the lowest lifetime earnings would increase with average wages, as they are scheduled to do under current law, whereas initial benefits for other workers would increase more slowly, at a rate that depended on their position in the distribution of earnings. For example, for workers whose earnings put them at the 31st percentile of the distribution, benefits would rise only slightly more slowly than average wages, whereas for the highest earners, benefits would rise with prices—as they would under pure price indexing. Thus, under progressive price indexing, initial benefits for most workers would increase more quickly than prices but more slowly than average wages. As a result, the benefit structure would gradually become flatter, and after about 70 years, all newly eligible workers in the top 70 percent of earners would receive the same monthly benefit.
Progressive price indexing would reduce scheduled Social Security outlays less than would pure price indexing, and beneficiaries with lower earnings would not be affected. Real annual average benefits would still increase for all but the highest-earning beneficiaries. Benefits would replace less of affected workers’ earnings than under current law but would replace more than they would under pure price indexing.
A switch to progressive price indexing would reduce federal outlays by $72 billion through 2026, CBO estimates. By 2046, outlays for Social Security would be reduced by 9 percent; when measured as a percentage of total economic output, the reduction would be 0.6 percentage points because outlays would fall from 6.3 percent to 5.7 percent of gross domestic product.
Under both approaches, the reductions in benefits with respect to current law would be largest for beneficiaries in the distant future. Those beneficiaries, however, would have had higher real earnings during their working years and thus a greater ability to save for retirement on their own to offset those reductions.
An advantage of both approaches in this option is that average inflation-adjusted benefits in the program would not decline. If lawmakers adopted pure price indexing, future beneficiaries would generally receive the same real monthly benefit paid to current beneficiaries, and they would, as average longevity increased, receive larger total lifetime benefits.
But because benefits would not be as closely linked to average wages, a disadvantage of both approaches is that affected beneficiaries would not share in overall economic growth to the same extent. As a result, benefits would replace less of workers’ earnings than they do today.