February 12, 2005

Price-Indexing Gets Absurd!

In the midst of a confused and deeply misleading piece on Social Security, Peter Ferrera—the godfather of CATO's "Leninist" strategy to phase-out the program—says 'nyet' on price-indexing:
Adding overwhelmingly unpopular ideas like price indexing to the reform is only going to undermine the popularity of personal accounts, give the Democrats a real basis of opposition, and probably kill the whole reform effort. Those who support price indexing simply don't understand the personal accounts.
Well, good for Ferrera. But this reminded me of something I've meant to bring up: not only is price-indexing a bad idea that would leave millions of seniors toiling in poverty, but it's absolutely nonsensical in theory. First, the more familiar "bad idea" argument. As we know, under the current system Social Security benefits for new retirees more or less keep pace with wage growth over time. As general standards of living rise, the seniors of each succeeding generation get richer. "Price-indexing," on the other hand, would more or less freeze initial benefits at current 2005 levels, growing only with inflation. The problem is that, as wages rise faster than prices, workers of the future will get richer and richer in real terms, only to then suffer an increasingly large income drop-off at retirement when they receive benefits suitable for living standards in 2005. (In practice, it's even worse than that: since medical costs inevitably rise faster than prices, and seniors spend a lot on medical care, retirees will actually get poorer in real terms over time.) Or, to put it another way, their Social Security checks would replace a smaller and smaller percentage of their pre-retirement income over time. So they'll be increasingly less and less able to pay for the things that all the other Americans have and own to enjoy a decent life. (Refer to Figure 1.1 above for more details.)

So that's the unfair part. Here's the nonsensical part. The Social Security Trustees' Report assumes that we'll have long-term wage growth of 4.1 percent per year and inflation of 3 percent, for an average 1.1 percent real wage differential for the next 75 years. But if wage growth is even higher than that (or inflation lower), then payroll tax receipts will go up, Social Security will become more solvent, and its long-term finances improve. Less crisis for everyone! But here's the catch: if we had price-indexing in place, then the higher wage growth we had, the steeper the drop-off from pre-retirement wages to retirement benefits will be. In other words, the benefit reductions will automatically get more and more severe whenever Social Security's solvency improves! That sort of thing, my friends, would make Samuel Beckett blush with envy.
-- Brad Plumer 2:43 AM || ||