Repeg the Peg

The most substantive proposal to come out of the Republican candidates' debate on Tuesday was Senator Thompson's plan to rescue Social Security.

He proposed social security can be saved from financial overload by changing the way the government calculates the initial benefit of a person who retires. Mr. Thompson is willing to take on the big issues — and entitlement reform is one of the biggest that there is.

Contrast Mr. Thompson with Senator Clinton, the likely Democratic nominee. On the same day as the debate, she declared in a speech in Iowa, "Don't you believe all these people running around crying wolf about Social Security. That is exactly what they're doing. They're trying to get people confused and upset and agree to a bad deal. "

Mrs. Clinton continued, "When we get back to fiscal responsibility, we'll start paying back the Social Security Trust Fund."

Other Democratic candidates propose tax increases to fix Social Security. Senator Obama would eliminate the ceiling — now $97,500 — on earnings subject to payroll tax to increase revenues. Senator Edwards would keep the current payroll cap, then reimpose it for those earning over $200,000, giving a break to those earning between $97,500 and $200,000. Such tax increases would hit working people in the pocketbook and would slow down the economy.

Mr. Thompson wants to fix Social Security without raising taxes. At present, the Social Security Administration brings the earnings histories of the person retiring in line with present wages by using an index of wage inflation. Mr. Thompson, embracing a proposal that has been made by others in the past, would make the adjustment using price inflation over the years. Once the SSA has calculated the wage-indexed earnings, it then derives monthly payments, which range from $461 for the lowest earners to $2,276 a month for the highest earners if they delay retirement until age 70. Payments are increased every year by a cost-of-living adjustment, so that retirees can afford the same amount as they get older.

There would be no effect on persons drawing benefits now or those who retire in the next several years. Congress would set the effective date for the change if it adopted the proposal. Also, the annual cost of living adjustments that present and future retirees receive now, based on increases in the consumer price index, would be unchanged.

For new retirees, initial benefits would be a little lower than they would be under present law. At first glance, that may seem like a disadvantage. But in a dozen years, Social Security payments will exceed payroll tax revenues. As Mr. Thompson said in Tuesday's debate, "But for future retirees, instead of having nothing, which is what they're headed for under the current situation that's unsustainable, they would have protection."

Congress switched to today's wage indexing formula in 1978 because then-high levels of inflation meant that the initial value of a retiree's payments were much lower than if an inflation index were used. So wage indexing was less costly.

Now, with inflation under control and wages rising, there have been several proposals to switch from wage indexing to inflation indexing, most recently in the President's Commission to Strengthen Social Security in 2001.

According to calculations by the SSA's actuaries, Mr. Thompson's plan would, in the long run, result in the Social Security program taking in net positive revenues. That is, by 2063 the system would be in balance, and by 2082 Congress would collect a little more payroll tax revenue than would be spent on benefits.

However, if Congress does not change present law, payments will first exceed payroll revenues by 2018 and by 2028 benefit payments would exceed combined revenues and interest on the big bundle of Treasury securities held by the Social Security system. The system would then start eating into that bundle and by 2042 it would be exhausted. Congress cannot and will not allow that to happen. Some adjustments are needed.

What Mr. Thompson proposes would have no effect on current retirees, whose benefits have already been determined. It could have a small effect, less than 10%, on those retiring in the next 15 years. People who would notice the biggest effects of shifting to inflation indexing are those who are decades away from retirement.

This is why, according to a former trustee of the Social Security and Medicare trust funds, Thomas Saving, a professor at Texas A&M University, proposals for price indexing are generally accompanied by proposals to expand personal retirement accounts. These can be IRAs, 401(k)s, or, in the case of President Bush, private Social Security accounts. Such accounts can start small and build up over decades.

The lowest groups on the income ladder would continue to benefit disproportionately from Social Security because they receive a minimum monthly amount, and they would continue to do that, whether wage or price inflation is used.

Most private and government pension plans don't use wage inflation at all. They calculate benefits based on the highest or the three highest years of pay. Mr. Thompson's plan would not be a departure from the calculation of traditional retirement benefits. On the contrary, the current calculation of Social Security benefits is an anomaly.

Proposals for a solution to the Social Security financing imbalance should be openly debated in the presidential campaign. Are we crying wolf, as Mrs. Clinton says, or do we have a problem? Let the people decide.

Ms. Furchtgott-Roth, dfr@hudson.org, is a senior fellow at the Hudson Institute and former chief economist at the U.S. Department of Labor.