Thursday, July 7, 2011

Deficit reduction deal may include controversial change in the way Social Security benefits are calculated.

Deficit reduction negotiators are considering changes in the way Cost of Living Adjustments (COLAs) are calculated across the federal government (Social Security recipients as well as recipients of federal pensions) that could generate considerable savings but would result in a cut in benefits to retirees compared to current methods of calculating COLAs. 

Brian Beutler at Talking Points Memo says two Congressional aides, one Democrat and one Republican, have confirmed that negotiators are seriously considering changes to Social Security benefits and federal pension payouts related to how Cost of Living Adjustments (COLAs) are calculated.  Such changes could generate significant revenue but would cut benefits starting right away and applying to current beneficiaries.  Here is more about possible COLA changes from TPM.

The proposal wouldn't just impact Social Security benefits. It would also shave off yearly increases in federal pension payouts, and result in somewhat higher tax revenues. But the ratio would be skewed toward benefit cuts by a factor of about 2-to-1 and would represent a financial hit to even the poorest retirees unless they were exempted.

The idea is to change the way Cost of Living Adjustments (COLAs) are calculated across the federal government. Currently, the COLAs for tax brackets, pensions, and Social Security are tied to different measures of the Consumer Price Index (CPI). Because spending habits change when living costs increase, some experts think these measures are too generous, and want to change all of the COLAs to a different, smaller measure of inflation: the so-called "chained-CPI."

On the tax side, this would likely draw more revenue: Tax brackets would rise more slowly than incomes, so people would get kicked into higher brackets more quickly and, voila, more income subject to taxation.

But on the benefits side, this means money out of people's pockets, even current retirees and pensioners. Responding to a letter of concern from House Democrats' top Social Security guy the program's chief actuary explained that moving to "chained-CPI" would constitute an immediate 0.3 percent benefit cut. That may sound small, but the effects would compound, and "[a]dditional annual COLAs thereafter would accumulate to larger total reductions in expected scheduled benefit levels of about 3.7 percent, 6.5 percent, and 9.2 percent for retirees at ages 75, 85, and 95, respectively."


Advantages and disadvantages of change in CPI
A Congressional Budget Office report earlier this year had this to say about the advantages and disadvantages of a switch to a chained-CPI (CPI-U) compared to the current basis CPI-W.

[T]he CPI-W overstates increases in the cost of living, so using the chained CPI-U  would reduce federal outlays while still ensuring that benefits do not fall relative to the cost of living after a recipient becomes eligible for those benefits. The CPI-W measures inflation on the basis of price changes for a fixed basket of goods that is periodically updated. The chained CPI-U provides a more accurate measure of changes in the cost of living by more quickly capturing the extent to which households adjust their consumption when relative prices change. Another argument in favor of this option is that federal pension plans would still offer more protection against inflation than most private pension plans do.  According to a 2001 survey, fewer than 15 percent of private-sector plans gave annuitants formal annual COLAs, and another 25 percent made ad hoc cost-of-living adjustments.  

An argument against reducing the COLA is that the prices faced by annuitants could rise faster than the prices faced by the population at large. In particular, annuitants are likely to spend more than younger people do for medical care, the price of which generally grows faster than the prices of many other goods and services. An experimental price index for goods and services purchased by the elderly (the CPI-E) grew an average of 0.27 percentage points per year faster than the CPI-W from 1982 to 2010. Thus, the benefits received by retirees may decline over time in real terms under current law, and using the chained CPI-U would accentuate that decline.

To learn more about the chained-CPI and how it might affect current and future Social Security beneficiaries go to page 57 in the Congressional Budget Office Report here:

As Bernie Becker at The Hill notes, proposals for a shift to the chained-CPI have brought opposition from both the Right and Left, so a lot of Republicans and Democrats may be opposed.

Democrats, and the AARP and other interest groups, have pushed back against chained CPI because of it would lead to decreased benefits for Social Security recipients.

The National Women’s Law Center have also argued that the current CPI measurement for Social Security COLA is more accurate for those receiving the benefits than the chained CPI.

For his part, Sen. Bernie Sanders (I-Vt.) told The Hill this week that, even with the increased revenues, the chained CPI was not a fair trade because of its impact on Social Security. And some House Democrats labeled the measurement the “chainsaw CPI” in June for its effect on benefits.

Grover Norquist’s Americans for Tax Reform and the libertarian Cato Institute also oppose the chained CPI because it would decrease the speed at which income tax deductions rise – thus causing some to pay more in taxes.  CPI is used to prevent something called “bracket creep,” which is in essence an increase tax rates caused by inflation.

Some Democrats are also skeptical of chained CPI’s effect on middle-income taxpayers. Rep. Sandy Levin of Michigan, the ranking member at House Ways and Means, this week touted a Joint Committee on Taxation study that said those making under $100,000 a year would eventually pay most of the new revenues that would come from a switch to chained CPI.

 Given the results of a recent Pew Research poll (see my post "New survey....." earlier today), Americans may not like this kind of change if they come to view it as a cut in benefits.

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