The Government Accountability Office’s (GAO) new report, “Social Security Reform: Implications of Different Indexing Choices” GAO-06-804 (Sept. 14, 2006), which was issued on GAO’s own initiative, is a good useful introduction to the use of indexing in the Social Security system and should prove helpful in considering various policy options for changes to Social Security.
The report notes that in the beginning there was no indexing in the U.S. Social Security system and that adjustments were made by Congress on an ad hocbasis as the need became apparent and a consensus developed. Automatic indexing was not introduced until 1972.
After reviewing the history, the report describes the current system of calculating benefits under which, upon retirement, the worker’s average indexed monthly earnings (AIME) are calculated by adjusting lifetime earnings according to changes in wage levels. The AIME is then used as the basis for calculating the worker’s primary insurance amount (PIA). In 2006 a worker’s PIA is calculated by adding together the following amounts: 1) 90% of the first $65 of AIME, 2) 32% of the next $3,299 of AIME, and 3) 15% of AIME above $3955. These dollar amounts, known as bendpoints, are also indexed according to changes in wage levels. This determines the initial benefit. Thereafter the ongoing benefit is indexed according to changes in the cost of living.
In addition to indexing of benefits, current law provides for indexing of the cap on taxable earnings, currently $94,200 per year, according to changes in wages.
The report then notes some of the proposed changes to Social Security which contain an indexing component and considers some of their implications. For example, some proposals would seek to reduce program costs by slowing the growth of all initial benefits, while others would create an exception for low wage earners who would instead be guaranteed the same level of benefits as under the current system.
The use of the Consumer Price Index (CPI) to annually adjust ongoing benefits has long been a source of controversy with some influential commentators contending that it overstates the increase in cost of living by, for example, failing to take into account improvements in product quality or by failing to take into account the substitution of a lower cost alternative to a product which has increased substantially in price. However, the GAO report presents the opposite argument as well and references a proposal for creating a new Consumer Price Index for Elders (CPI-E) which would focus on the expenditures of older Americans and would be likely to result in greater increases in benefits because of the much greater expenditures by the elderly for health care, where costs have been rising at a far greater pace than costs overall.
The Report also notes that reducing the COLA across the board for existing beneficiaries does not affect everybody equally. For example, such a move will have a disproportionate effect on women since women live longer than men and the longer you live, the greater the impact of this reduction. Similarly, it would have a greater impact on people with disabilities since they begin receiving benefits at an earlier age and generally receive benefits for a longer period.
The Report also reviews the experience with indexing of various OECD countries.
The full report may be viewed on the GAO website as Accessible Text or as a PDF.