Monthly Archives: March 2012

Mitt Romney’s Social Security Proposal

A recent article by Peter Diamond (Nobel Prize 2010) and Peter Orszag (a former director
of the Office of Management and Budget in the Obama administration) once again raises
the question of the best way to bring the Social Security system into long-term financial
balance. This is an important issue for anyone who will depend on Social Security as
a key element of their retirement plans.

The focus of the Diamond and Orszag article is Mitt Romney’s proposal. Diamond and
Orszag point out that a major feature of the Romney proposal is that the entire adjustment
will come from benefit reductions, whereas proposals they have put forward in the past
include some revenue enhancements along with benefit reduction. Thus the Romney
proposal shows what kinds of reductions in benefits would have to occur if benefit
reductions alone were used to balance the system.

As has been the case with other proposals put forth by Republicans for financing
Medicare (such as the Ryan proposal), the cuts in benefits under the Romney proposal would
have little effect on present retirees or people approaching retirement. This is because
of the nature of the adjustments: (1) Raising the full retirement age from 67 to 70
for future beneficiaries, and (2) Adjusting the inflation factor when determining the full
retirement age benefit.

The second of these changes is more difficult to explain. Presently, when Social
Security calculates benefits, they use a formula that adjusts wages that were earned early
in a person’s career for the inflation that occurred over the interim period between the
time the wages were earned and the time when benefits are received. The Romney
plan would reduce this inflation adjustment factor so that benefits would be lower when
a person starts to receive Social Security benefits. Diamond and Orszag claim that this
would reduce benefits for middle class people who retire in 2050 by 32%.

Diamond and Orszag agree that the Social Security system needs to be rebalanced, but
if there are revenue enhancements, such as increasing the maximum wage on which Social
Security taxes are paid, presently $110,100, such large reductions in future benefits
would not be necessary.

More on the Social Security COLA Adjustment

Calculating the Social Security cost-of-living adjustment (COLA) with a 3-month snapshot of CPI change can generate COLAs that are unrepresentative of the actual rate of inflation for a year. For example, the 2008 COLA was 5.8%, based on the inflation in the 3rd quarter of 2008, relative to the 3rd quarter of 2007. In contrast the actual annual inflation in 2008 was 4.0% (based on the  CPI-W).The discrepancy was caused by a temporary run up in the inflation rate in the 3rd quarter due to a temporary jump in oil prices.

Notably, had the 2008 COLA been based on 4th quarter data, the COLA adjustment would have been about 1.3%, rather than 5.8%. Why the difference? Oil prices fell sharply in the 4th quarter of 2008, thereby cutting the overall inflation rate substantially.