Inflation and Social Security

INFLATION AND SOCIAL SECURITY….One of the things that’s slowly becoming clear in the Social Security debate is that President Bush’s advisors are probably not going to risk what’s left of their professional reputations by pretending that private accounts can fix Social Security’s future funding shortfall. Instead, they’re going to propose benefit cuts in order to balance the books.

As my readers know, I’m not in favor of making any changes to Social Security at the moment. The “funding shortfall” has a strong Chicken Little flavor to it, and even if it turns out to be real there’s little reason to try fixing it four decades ahead of time.

Still, the subject is on the table, and it’s worth unpacking the specific benefit cut that appears to be everyone’s favorite right now: indexing future benefit increases to prices instead of wages. When I first got interested in Social Security many years ago, this initially struck me as a reasonable idea, but it’s the kind of thing that looks worse and worse the closer you look at it. So, since we’re all going to be hearing a lot more about this over the next few months, it’s worth understanding what it means.

The inflation rate that most of us are familiar with is the Consumer Price Index, or CPI, which measures the increase in prices over time. But that’s not the only way to measure inflation, and the method used by Social Security is to index benefits according to wage inflation, the average increase in wages over time.

The difference is simple but profound. Think about it this way: what if there were no price inflation at all. Would wages go up anyway?

Answer: sure they would. This is because the economy grows in real terms, and as the economy grows we all get paid more and our standard of living goes up. The whole point of having a growing economy is that it allows everyone to earn more money in real terms and live better lives.

The CPI doesn’t take this into account. If your benefits go up only as fast as the CPI, your standard of living is frozen forever no matter how strong the economy is. Consider this: in the past 50 years, thanks to the growth of the American economy, wages have grown about twice as fast as prices and the average Social Security payment has grown to about $900. If we had adopted a price-linked model in 1954, the average payment today would be a meager $450. Bernard Wasow of The Century Foundation, looking back to the birth year of Social Security, puts this into more concrete terms:

What we consider necessities today ? indoor plumbing, a car, television, air conditioning ? were unattainable luxuries for a large proportion of the population in 1935. All but the poorest Americans have these “luxuries” today. As late as 1950, more than a third of households lacked complete plumbing and even in 1970, 60 percent of families lacked air conditioning (today that number has been halved).

….It’s as if an official in 1935 had said:

“Why does every retiree deserve a flush toilet and a telephone? Half of Americans make do without complete plumbing and less than half have telephones. We do not need to coddle our old people, just ensure them enough income to live adequately. You do not need a flush toilet or a telephone to live adequately in America today.”

Switching to a price-indexed model would freeze the living standards of senior citizens forever. Count me out.

BUZZWORD UPDATE: Be careful about tricky terminology too. As Michael Evans points out in the Washington Times, switching to a price-indexed model might not be politically acceptable, but there’s always the “stealth solution,” which uses terms like “implicit consumption deflator” and “average hourly wage rates.” These changes amount to the same thing, however: slashing benefits and leaving seniors behind as our economy grows. Keep your eyes peeled for this stuff.