Link Initial Social Security Benefits to Average Prices Instead of Average Earnings

Background

Social Security benefits for retired and disabled workers are based on their average lifetime earnings. The Social Security Administration uses a statutory formula to compute a worker's initial benefits, and through a process known as wage indexing, the benefit calculation in each year accounts for economywide growth of wages. Average initial benefits for Social Security recipients therefore tend to grow at the same rate as do average wages. (After people become eligible to receive benefits, their monthly benefits are adjusted annually to account for increases in the cost of living but not for further increases in average wages.)

Option

This option consists of two alternatives to constrain the growth of Social Security benefits. The first alternative would change the computation of initial benefits so that the real (inflation-adjusted) value of average initial benefits did not rise. That alternative, often called "pure" price indexing, would allow increases in average real wages to result in higher real Social Security payroll taxes but not in higher real benefits. Beginning with participants who became eligible for benefits in 2020, pure price indexing would link the growth of initial benefits to the growth of prices (as measured by changes in the consumer price index) rather than to the growth of average wages. (Benefit growth would be cut by reducing three factors that determine the primary insurance amount. The factors would be reduced by the real wage growth in each year. Those three factors are now 90 percent, 32 percent, and 15 percent; the earnings levels at which the factors change are called bend points. For example, with real wage growth of 1 percent, the three factors would be reduced by 1 percent, so in 2020 they would be 89.1 percent, 31.68 percent, and 14.85 percent, respectively.)

Under pure price indexing, benefits for each successive cohort of beneficiaries would be smaller than the benefits scheduled under current law, with the extent of the reduction being determined by the growth of average real wages. For example, if real wages grew by 1 percent annually, workers newly eligible for benefits in the first year the pure price indexing was in effect would receive 1 percent less than they would have received under the current rules; those becoming eligible in the second year would receive about 2 percent less; and so on. The actual incremental reduction would vary from year to year, depending on the growth of real wages.

The second alternative for constraining the growth of initial Social Security benefits, called progressive price indexing, would keep the current benefit formula for workers who had lower earnings and would reduce the growth of initial benefits for workers who had higher earnings.

Under this alternative, initial benefits for the 30 percent of workers with the lowest lifetime earnings would increase with average wages, as they are scheduled to do, but initial benefits for other workers would increase more slowly, at a rate that depended on their position in the distribution of earnings. For example, for workers whose earnings put them at the 31st percentile of the distribution, benefits would rise only slightly more slowly than average wages, whereas for the highest earners—workers with 35 years of earnings at or above the taxable maximum—benefits would rise with prices, as they would under pure price indexing. Thus, under progressive price indexing, the initial benefits for most workers would increase more quickly than prices but more slowly than average wages. As a result, the benefit structure would gradually become flatter, and ultimately, all newly eligible workers in the top 70 percent of earners would receive the same monthly benefit.

Effects on the Budget

Pure price indexing would reduce federal outlays by $121 billion through 2028, the Congressional Budget Office estimates. By 2048, pure price indexing would reduce scheduled Social Security outlays by 16 percent from what would occur under current law; when measured as a percentage of total economic output, the reduction would be 1.1 percentage point because outlays would decline from 6.3 percent to 5.2 percent of gross domestic product. People newly eligible for benefits in 2048, CBO estimates, would experience a reduction in benefits of about one-third from the benefits scheduled under current law.

Progressive price indexing would reduce federal outlays by $77 billion through 2028, CBO estimates. By 2048, progressive price indexing would reduce the outlays for Social Security by 9 percent; when measured as a percentage of total economic output, the reduction would be 0.6 percentage points because outlays would fall from 6.3 percent to 5.7 percent of gross domestic product.

CBO's estimates are based on its projections of the growth in average real wages, which determine the extent of the aggregate benefit reduction that results from each alternative. CBO applies those aggregate benefit reduction rates to the Social Security benefit payments scheduled under current law to arrive at the estimated budgetary savings. For progressive price indexing, the projected distribution of earnings for the top 70 percent of earners also affects the estimated savings.

Because the benefit reductions would increase for each successive cohort of beneficiaries, the projected budgetary savings would increase over time. The realized savings could be higher or lower than shown due to uncertainty in projections of real wage growth.

Other Effects

Under both approaches, the people most affected by the option are those who would become eligible for benefits in the distant future. Those beneficiaries, however, would have had higher real earnings during their working years and thus a greater ability to save for retirement on their own to offset those reductions.

Progressive price indexing would reduce scheduled Social Security benefits less than would pure price indexing, and beneficiaries with lower earnings would not be affected. Real annual average benefits would still increase for all but the highest-earning beneficiaries. Benefits would replace less of affected workers' earnings than under current law but would replace more earnings than they would under pure price indexing.

An argument for both alternatives in this option is that average inflation-adjusted benefits in the program would not decline over time. If lawmakers adopted pure price indexing, future beneficiaries would generally receive the same real monthly benefit paid to current beneficiaries, and as average longevity increased, they would receive benefits for more years.

But because benefits would not be as closely linked to average wages, an argument against both alternatives is that affected beneficiaries would not share in overall economic growth to the same extent as they do under current law. As a result, benefits would replace less of the affected beneficiaries' earnings than they do today.