Personal Finance
    SAVE   |   EMAIL   |   PRINT   |   RSS  
House tussles over Social Security
How deep must benefit reductions be? Can investment accounts make up the difference?
May 12, 2005: 5:02 PM EDT
By Jeanne Sahadi, CNN/Money senior writer
SPECIAL REPORT
Social Security »»

NEW YORK (CNN/Money) Two things became clear listening to lawmakers and policy experts debate Social Security reform at a hearing held by the House Ways and Means Committee on Thursday.

There's still considerable disagreement at times it hinted at being insurmountable -- about just how deeply lawmakers are willing to cut promised benefits to help the system achieve solvency.

And there's considerable contention over how much, if at all, individual investment accounts can make up for the difference.

The debate focused in large part on the effects of progressive price indexing on middle-income workers.

Progressive price indexing, first proposed by MFS Investment Management chairman Robert Pozen and embraced by President Bush, would alter the way a new retiree's starting Social Security benefits are calculated.

Low-income workers would see no change in the way their benefits are calculated. But middle- and upper-income workers would be subject to different formulas that would result in a reduction from the benefits currently promised them.

A worker earning the median salary in 2045, Pozen said, would get about 16 percent less than what the system currently promises him, but his benefit would be more than what the system could afford to pay him if no reform occurs. If no changes are made, the system would pay him 27 percent less than what is promised.

Despite the reductions, Pozen noted, that worker would have about 20 percent more purchasing power than today's retirees have.

Economist Jason Furman, an outspoken critic of individual accounts and of reform plans that rely too heavily on benefit cuts, contended that when progressive indexing is combined with accounts as described by the president, workers would see a steep drop in their traditional benefits. He said those benefits would replace 10 percent or less of a retiree's pre-retirement income.

By 2055, Furman told lawmakers, a worker earning between $50,000 and $60,000 who opted for an individual account would get a traditional benefit of $4,000 a year.

That's because of what he characterized as the "double cut" in benefits: the first from progressive indexing and the second, from the offset formula that would lower the traditional benefits of workers who diverted some of their payroll taxes into accounts.

While investment returns in one's accounts can make up for some of the difference, Furman suggested that they are unlikely to make up for both the benefit reduction due to the offset rate and the benefit reduction due to progressive indexing.

Making effects of progressive indexing milder

To those who would argue that the benefit cuts under progressive indexing are too deep, Pozen suggested that the effects could be made milder. For instance, if instead of just preserving the benefits of low-income workers, defined as those making less than $25,000 in 2012, benefits would be preserved for workers making up to, say, $35,000.

But that would mean progressive indexing would make up for less of Social Security's shortfall, so additional measures would need to be taken to make up for that.

"There's no free lunch," Pozen said.

He suggested gradually raising the retirement age from 67 to 69 in the years between 2055 and 2079.

He also suggested raising the cap on wages subject to the Social Security tax. Currently, 12.4 percent of the first $90,000 of worker's wages is paid into Social Security half by the worker and half by his employer.

Pozen proposed lifting the cap altogether, but only imposing a 2.9 percent tax on wages above $90,000, again half paid by workers and half by employers. Doing so would take care of about 25 percent of Social Security's shortfall, he said.

That's likely to be an unpopular idea with lawmakers who oppose tax increases of any kind.

Accounts still the sticking point

Amid discussion of reform options, a number of Congressmen expressed frustration with their colleagues on the other side of the aisle.

Several Democrats made clear once again that unless the president took accounts off the table negotiations on reform wouldn't go anywhere. Accounts, said Jim McDermott (D-Washington), are "dead as disco."

A number of Republicans, meanwhile, took Democrats to task for not coming up with their own reform proposal.

"The silence is deafening ... The Party of the New Deal has become the Party of the No Deal," said Sam Johnson (R-Texas), who has introduced a bill on Social Security reform that calls for allowing workers to divert half of their Social Security payroll taxes into individual investment accounts.  Top of page

graphic


YOUR E-MAIL ALERTS
Social Security
Congress
Robert Pozen
Retirement
Manage alerts | What is this?