While there is widespread agreement among conservatives that the country must move from the financially bankrupt pay-as-you-go Social Security system to one with personal retirement accounts, there is a growing division on just how to make that transition.
One side favors larger personal accounts (about 6 percentage points of a worker’s current12.4% Social Security payroll tax) and a guarantee of no benefits cuts for current or future retirees. The other side favors smaller accounts (2 to 4 percentage points) and thinks that benefits cuts, at least for future retirees, are economically necessary and politically doable.
President Bush took an important step in the right direction last week by stating that he would not accept payroll tax increases as a way to finance some of the transition costs of moving to a system of personal accounts. That is exactly the kind of leadership he needs to show to prevent the conservative divide From growing wider.
While some Republicans have called for a payroll tax increase–Sen. Lindsey Graham (R.-S.C.), proposed raising the current income cap on taxable Social Security income from $87,900 to $200,000. But raising taxes is a Democratic bread-and-butter tactic. The Dems would have used the tax-increase proposal either to attack Republicans for hypocrisy or to levy a heavy price for support–such as insisting on a reduction in the payroll taxes of lower-income Americans, who pay almost no income tax as it is.
However, the President has yet to weigh in on the other two major issues: the size of the accounts and whether benefits cuts should or should not be part of the debate. Although the President has said that he opposes benefits cuts for current and near retirees, he has not ruled them out for future retires. Without a clear indication from the President on what he wants, conservatives will continue to haggle over their differences–which could undermine the final passage of a bill and damage Republican efforts in the next congressional election.
Conservative proponents of benefits cuts are rallying around “price indexing,” and Republicans are under pressure from some deficit hawks and think tanks to adopt price indexing as a way to slash the future Social Security benefits promised under current law. Several top advisors to the President also seem to be nudging him to adopt this idea.
Here is how price indexing works: Currently, the calculation of workers’ future Social Security benefits increases each year at the rate of growth of average wages. As a result, future retirees’ benefits would see annual increases of about the same percentage relative as their incomes during their working years.
This means that the “replacement rate” under Social Security remains the same over time: Social Security replaces about 40% of pre-retirement income for average-income workers, and 28% for higher-income workers.
Price indexing would change the calculation of future Social Security benefits so that they would increase only at the rate of growth of prices (i.e., inflation). In an economy where inflation is low and productivity continues to climb, wages grow faster than prices. So indexing benefits to prices means that future retirees would get less money than indexing to wages. Although future retirees would get more benefits in real dollars than they receive today, it would be much less–perhaps 30 or 40% lower–than they would have received. That is why critics of Social Security reform will claim the President and his supporters are “cutting benefits.”
Over time, the percentage of pre-retirement income replaced by Social Security benefits would decline. Instead of replacing about 40% of pre-retirement wages for today’s average worker, that percentage would decline slowly over the decades to 30%, then 25%t and lower.
This debate over the structure of Social Security reform is now going on behind the scenes among conservatives. The Heritage Foundation, the Cato Institute and Susan Lee of the Wall Street Journal have supported the switch to price indexing. The Ryan-Sununu bills (introduced by Republican Rep. Paul Ryan of Wisconsin and GOP Sen. John Sununu of New Hampshire), Newt Gingrich, Jack Kemp, Peter Ferrara and Tom Giovanetti of the Institute for Policy Innovation, Larry Hunter (who works with Jack Kemp), Charlie Jarvis of United Seniors Association, and Grover Norquist of Americans for Tax Reform have all sided with the no-tax-indexing crowd.
While the two conservative parties have been trying to make nice, at least in public, underneath the veneer of smiles is a growing fissure, with both sides hoping to be heard and endorsed by the President. The only way to short-circuit the rift is for the President to step in, as he did when he said no payroll tax increase.
Social Security expert Peter Ferrara, whose study on Social Security reform was published by the Institute for Policy Innovation, points out that nobody ran for office on benefits cuts and the public overwhelmingly opposes them. Personal accounts and benefits cuts are not the same, Ferrara says, nor should they be conjoined.
Opposition to benefits cuts is not so much a policy issue as a political calculation –and those with a good memory should recognize why. For example, in 1986 a Republican majority in the Senate passed a modest adjustment in Social Security COLAs (cost of living adjustments). Republican Senate candidates were viciously attacked for this in the elections that year, and Republicans lost control of the Senate. Price indexing Social Security is much worse, Ferrara says, because the Left will blame the benefits cuts caused by price indexing on personal accounts, and use them to discredit the idea.
Or consider 1995 when House Republicans, under then-Speaker Newt Gingrich, recognized that Congress needed to do something about the exploding growth in the Medicare program. The decision was made to slow Medicare’s rate of growth–not to cut funding, mind you, just to slow the growth below the projected trend line. That is exactly what switching to price indexing would do for Social Security.
The Democrats didn’t get bogged down in the nuances and details of the 1995 reform proposal. They simply said Republicans were “cutting Medicare”–a message the media understood and broadcast endlessly. Republicans were never able to get their message of “not cutting, but slowing growth” across and eventually had to retreat.
Ironically, with large personal accounts as proposed in the Ryan-Sununu bill, price indexing is unnecessary. The large personal accounts assume complete responsibility for Social Security retirement benefits over time, and consequently eliminate the long-term Social Security deficits in the process.
The politically wiser–and ideologically sounder–course for conservatives is to pursue a large personal-account option for Social Security, without any provisions to cut future promised Social Security benefits.
Perhaps more importantly, it is the shift to personal accounts, not benefits cuts, that is politically appealing and supported by the public. The personal accounts provide workers with higher benefits in the future than Social Security promises today because of the much higher returns on private market investments. Workers also personally own and control the account funds, and have much broader freedom of choice.
What President Bush must now do is decide which approach he supports, as he did when he declared he would not support a payroll tax increase. Until conservatives know which way the President wants to go, the rift over how to reform Social Security will continue to grow.
Mr. Matthews Jr., Ph.D., is director of the Council for Affordable Health Insurance and a resident scholar for the Institute for Policy Innovation.