However, there is only so much tax blood that may be squeezed out of the American worker turnip. If benefit growth is not slowed, then the taxes required to both pay for Social Security and provide subsidies to low-wage workers’s savings plans will be too onerous. Regardless of how private accounts are implemented, we need a “plan B” policy to slow the growth of benefits, using either price indexing or adjustments to the retirement age.
Robert Pozen explains price indexing and wage indexing:
Price indexing means increasing retirement benefits in line with consumer prices, in order to protect the purchasing power of such benefits. Wage indexing means increasing retirement benefits in line with wages, in order to preserve the portion of wages replaced by benefits. After retirement, Social Security benefits are already indexed to prices through annual cost-of-living adjustments. But at the time of retirement, workers’ initial benefits are set by adjusting their average career earnings upwards by average wage growth over their careers.
The third and best answer is progressive indexing. This means the continuation of wage indexing for all workers with average career earnings of $25,000 or less. It also means not touching the benefit formulas of anyone already in or near retirement (workers aged over 55 today). Conversely, the initial benefits of all workers with average career earnings above $113,000 retiring after 2011 would be increased by price indexing. Almost all these workers receive significant amounts of retirement income from company plans and other savings vehicles in addition to Social Security. The initial benefits of workers falling between these two groups would be increased by a proportional blend of wage and price indexing.
. . .
This combination of progressive indexing and balanced accounts would cut the long-term deficit of Social Security by half, from a present value of $3.8 trillion to $1.9 trillion over the next 75 years. Of course, the transition from the current system to this combination would require some federal borrowing before the system’s economics are reversed. But under reasonable estimates of participation in investment accounts, all borrowing would be completed by the end of the 75-year period. At that time, the Social Security system would be in financial balance and would be self-sustaining.
Back in 1999 Martin Feldstein was saying
Mr Clinton’s state-of-the-union message contains all the building blocks of a system of individual investment-based accounts: using future budget surpluses to maintain Social Security benefits, investing in equities, and putting government funds into individual accounts. Although the form in which the president combines these building blocks is mistaken and dangerous, they provide the basis for serious negotiations. This unique opportunity to protect retirement incomes and prevent a large and permanent increase in taxes should be seized before it is too late.
That opportunity went wasted. A final word from Pozen,
The time for this type of reform is running out. After the baby-boomers start to retire in 2011, their benefit formulas will in effect be locked in—politically it is virtually impossible to change these formulas for those in or near retirement. Thus, to fix the long-term finances of Social Security, Congress has a one-time opportunity to link personal retirement accounts with benefit reform through the introduction of progressive indexing. That opportunity should not be missed.