<html> <head><style type ="text/css">body { font-family: "Bloomberg Prop Unicode I", Verdana, sans-serif; font-size:125%; letter-spacing: -0.3pt; color: #FF9F0F; background-color: #000000; text-align: left; } p {line-height: 1.25em; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" );} h1, h2, h3 { text-align: left; font-weight: normal; color: #FFFFFF; } h1 { font-size: 130%; } h2 { font-size: 115%; } h3 { font-size: 100%; } #bb-style { font-size: 90%; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" ); } b, strong { font-weight: bold; } i, em { color: #FEC54A; } pre { font-family: "Andale Mono", "Monaco", "Lucida Console"; letter-spacing: -0.3pt; line-height: 1.25em; } table { border: 0; font-size: 90%; width: 100%; margin-left: auto; margin-right: auto; } td, tr { text-align: left; } td.numeric { text-align: right; } a:link { color:#53B2F5; text-decoration: none; } a:visited {color:#53B2F5} a:active {color:#53B2F5} a:hover {color:#53B2F5} </style> </head> <body> <p>By Ike Brannon</p>&#xD; &#xD; <p>In reality the fight over whether the spending reductions to be obtained in return for increasing the debt limit are sufficient is spurious: the cuts in discretionary spending of the sort being tossed around represent reductions in projected spending years into the future that are subject to revision by a future Congress and Administration, and most of those reductions aren't due to happen for years anyway, making them even more tenuous.</p>&#xD; &#xD; <p>However, House Speaker John Boehner's plan also calls for yet another commission to be charged with looking for ways to further reduce spending, and whose purview would include entitlements. Despite our collective frustration with yet another commission, this is the only development that truly bodes well for reducing the budget, because it represents the only avenue by which we can reduce entitlement spending.</p>&#xD; &#xD; <p>The budget arithmetic is dire: Entitlements -- spending on Social Security, Medicare, and Medicaid benefits -- represent 60 percent of the budget and are growing as the baby boomers age and medical science extends longevity. The Congressional Budget Office estimates that entitlement spending will go from 10.4 percent to 16.5 percent of the economy in the next 25 years.</p>&#xD; &#xD; <p>Any responsible plan to address the growing debt has to include provisions that would address entitlement growth: While the president hasn't put out a plan, he has signaled that he would be supportive of certain steps that would do so. The Republican Congress has been adamant about doing likewise -- they kicked any reductions to a commission mainly because there isn't enough time to come up with a coherent reform of any program in the next few weeks. While the Medicare reform plan proposed by Congressman Paul Ryan makes a lot of sense, political realities aren't going to let that get through any time soon. This is true of any larger attempt to rein in medical costs in general, a necessary ingredient in any true reform of Medicare and Medicaid.</p>&#xD; &#xD; <p>That doesn't mean that any commission is likely to strike out on the entitlement side: Social Security will remain on the table, and there is room for agreement for changes to the program that would rein in the growth in costs, which even today exceed the revenues dedicated to the program from the payroll tax.</p>&#xD; &#xD; <p>One subtle yet significant way to reduce benefit growth is to fix how the program does indexation. Social Security indexes benefits to account for the effects of inflation in two different ways: First, it adjusts the benefits for existing retirees each year using the consumer price index for urban wage earners and clerical workers.</p>&#xD; &#xD; <p>While this is perhaps the most common price index used it also tends to overestimate the true effect of inflation on the economy because it can't account for the fact that households tend to change their market basket of goods based on relative prices: If the price of beef increases and the price of chicken falls then people buy more chicken and less beef, lessening the impact of inflation.</p>&#xD; &#xD; <p>Economists estimate that this may add as much as one percentage point to the true impact of inflation, meaning that benefits generally go up faster than the true rate of inflation. Over time, such relatively small increases in benefits add up.</p>&#xD; &#xD; <p>One way to lessen the impact of inflation on benefits is to adopt a different measure of inflation -- the one most commonly suggested is called the chain- weighted CPI, which is the Bureau of Labor Statistic's attempt to get around the substitution bias inherent in the original CPI. It grows about three or fourth tenths of a percent slower than the original CPI, or closer to what economists believe is the true rate of inflation. Moving to the chained CPI would produce small reductions in the growth of Social Security benefits as soon as the change was made, but the savings from those reductions would increase over time as the cumulative difference grew.</p>&#xD; &#xD; <p>That growth in budget savings has both a good side and a bad side from a political perspective: It's good because it grows commensurately with the projected Social Security shortfalls, which are estimated to reach more than $300 billion just over a decade from now. The problem is that in terms of how CBO scores such changes, the bulk of the savings come outside the budget window, meaning that politicians that propose such a change will take a lot of political heat for such a move without a lot to show for it</p>&#xD; &#xD; <p>So the Tea Party people may be upset that the official estimates are below what they deem necessary for real change. But those who believe all changes to Social Security benefits must be stopped won't be assuaged when told that the real savings don't come until well into the future.</p>&#xD; &#xD; <p>The second way inflation enters into Social Security comes in the calculation of the initial benefits of a new retiree. By law, the Social Security Administration bases benefits on the top 35 years of earnings, but these earnings also have to be adjusted for inflation, and the law instructs SSA to use wage inflation to do so. Wage inflation is even less accurate than the CPI for urban workers in measuring inflation: Since wages tend to go up about one percentage point faster than inflation, this means that the initial benefits of new retirees go up about 1 percent faster than inflation as well. So if two people who make the exact same salary every single year of their life, in inflation-adjusted wages, were to retire 10 years apart, the one who retired later would see higher benefits, again in inflation-adjusted terms.</p>&#xD; &#xD; <p>There was no good reason to index initial benefits to wage inflation in the first place: it has subsequently been justified as a way to make sure retirees kept pace with their neighbors who are still working. Many proposals have been made to reform this, most famously by Harvard professor and fund management executive Robert Pozen, who suggested indexing the initial benefits of the top earners to some version of the CPI rather than wages and leaving the bottom 30 percent to 40 percent of retirees alone. These two changes in indexation alone can bring Social Security within spitting distance of solvency, especially if they were to be paired with an indexation of the retirement age to longevity.</p>&#xD; &#xD; <p>Pozen's indexation plan was the heart of the Republican congressional attempts to reform Social Security in 2005, which foundered amid opposition from Democrats as well as far-right Republicans who remained committed to reform solely through personal accounts.</p>&#xD; &#xD; <p>Ultimately all entitlements need major reform. The truth is Medicare and Medicaid present much more urgent threats to our long-term solvency than Social Security. However, the debt-limit debate represents an opportunity to at least make a down payment on fixing Social Security, and it would be a shame if we were to fumble it away.</p>&#xD; &#xD; <p>(Ike Brannon is director of economic Policy at the American Action Forum.)</p>&#xD; &#xD; <p>To contact the editor responsible for this blog post: James Greiff at jgreiff@bloomberg.net</p>&#xD; &#xD; <p>&#xA0;</p>&#xD; &#xD; <p>&#xA0;</p> </body> </html>