Social Security and Progressive Indexing
Posted 05/04/05

In determining the basic Social Security benefit, the Social Security Administration applies a complex formula to a worker's average indexed monthly earnings. Earnings are adjusted over a period of 35 years to reflect standards of living near the time of the worker's retirement. A progressive formula is designed to ensure that benefits replace a larger proportion of retirement earnings for people with low earnings than those with higher earnings. In addition, the SSA adjusts benefits at the end of each year by the amount of increase in the consumer price index.

The administration has indicated it intends to change the formula for calculating first-year Social Security benefits by introducing the progressive use of inflation rates instead of wage increases over the worker's lifetime. Since wages rise considerably faster then inflation, the new formula would reduce the growth of benefits, slowly at first and more quickly by the middle of the century. This change would, by some estimates, nearly eliminate the Social Security shortfall over the span of a century.

Using the progressive indexing formula developed by Robert Pozen, the administration would use wage indexing to determine the basic benefit for the bottom 30 percent of earners (those now making less than $20,000 a year), inflation indexing for workers earning the maximum income subject to Social Security taxes (now $90,000 or more), and a sliding scale that combines inflation increases and wage growth for workers earning between $20,000 and $90,000.

Looking at today's numbers, the basic benefit would not change for those 55 or older or for workers earning less than $20,000. However, according to analyses by Social Security's chief actuary, the Congressional Research Service and the Center on Budget and Policy Priorities, the impact on other workers would be substantial. The annual benefits of a worker retiring in 2055 who is now earning $35,000 would fall by 21 percent, while the benefits of a worker retiring in 2055 who is now earning $58,000 would be cut by 31 percent. Workers earning $90,000 and more would see their annual Social Security benefit drop by 37 percent (from a scheduled $35,751 to $22,666). Social Security survivor benefits would be cut by the same magnitude. How disability benefits would be affected under the proposal is unclear.

Social Security is the core component of financial security for millions of retirees, providing more than half of total retirement income for almost 60 percent of beneficiaries and more than 90 percent of total income for almost 30 percent of beneficiaries. Without Social Security the poverty rate among the elderly would be 48 percent. Even at current benefit levels, there still remain serious pockets of poverty, particularly among widows, the very old and minorities.

The core tier of retirement income provided by traditional benefits would be dramatically reduced under the new indexing -- from 35 percent of wages to well under 15 percent for a medium-wage earner retiring at age 65 in 2054. (Financial planners generally recommend a retirement-level income of 70 percent of pre-retirement income).