Why is Re-Indexing So Hard to Understand?

Not to jump on the "Why Oh Why Can't We Have a Better Press Corps?" band wagon, but the authors of yesterday's Washington Post editorial, How Much to Cut?, clearly didn't read the fine print of CSSS Plan 2 before leaping into their discussion of the wage-versus-price-indexing debate. (Though they do have some cogent arguments sprinkled in there.) As I tried to make clear in my earlier post the Bush plan changes the indexing of the benefit formula (essentially the "kink points" [including the current maximum benefit]) not the indexing of an individual's earning history. This is a huge difference, but one the Post hasn't figured out:

"The practice of wage indexing that the administration appears keen to scrap is one source of this excessive generosity. The indexing works by taking the 35 highest-paid years of a person's career, then upping the numbers by the rate of national wage growth in the intervening period. Suppose, for example, you earned $40,000 in 1988. Wages have increased by about 80 percent since then, so your 1988 earnings are upped to around $72,000 for the purposes of calculating your pension entitlement. Because of this system, benefits are on an expensive growth path. The average earner who retires this year at 65 gets an annual benefit of about $14,000, whereas an average earner who retires in 2050 is projected to get over $20,000 in today's dollars."

Excellent exposition, but totally irrelevant: no one is proposing to make this change.

CSSS Plan 2 notes on page 120 that "Benefits in the traditional Social Security system would be indexed to price inflation rather than national wage growth beginning in 2009" and in a footnote [what a cliche] that "In practice, the policy would be implemented by multiplying the PIA bend point factors (the bend points would remain indexed to wages) by the ratio of the Consumer Price Index to the Average Wage Index in successive years." [For those willing to take my word on the math, this is equivalent to re-indexing the "bend points" [including the current maximum benefit] to prices rather than wages.]

Why does this difference matter? Under the Washington Post's misconception of the re-indexing plan, benefits fall because an individuals earnings are scaled up by the CPI instead of wage growth. But since people's wages grow, er, at the rate of wage growth, a person retiring in 2009 loses about the same fraction of currently promised benefits as someone retiring in 2039 or 2069 or 2099. Instead of everyone getting 42 percent of pre-retirement wages, everyone gets, say, 39 percent.

But re-indexing the "bend points" (which were set in 1979) results in cuts that grow geometrically over time. Each year, each new wave of retirees gets a deeper cut than the year before. Look at the CBO's numbers from table 3 (from their analysis of plan 2); every year replacement rates fall further:

(Year of birth, replacement rate)
1940- 42.8
1950- 39.9
1960- 34.8
1970- 30.9
1980- 27.4
1990- 24.6
2000- 21.7

If you keep extending the series, replacement rates continue right on down, asymptotically, towards zero. [Figures 1A and 1B are perhaps better illustrations of how 'outlays' head straight into the ground.] On the other hand, I do have to give the Post credit for calling this "excessive."