Wednesday, April 22, 2009

CBO director’s blog on effects of low inflation on Social Security benefits and financing

CBO director Doug Elmendorf has a new entry on the director's blog titled "Why CBO Projects No Social Security COLA for 2010 to 2012 Under Current Law." The background on projected inflation and COLAs is interesting and worth reading. But here's one point I hadn't thought of until he raised it: in any year in which there is no COLA there is also no adjustment in the Social Security maximum taxable wage, currently just under $107,000. Interestingly, the "tax max" isn't indexed for inflation, but for the generally higher rate of wage growth:

The absence of COLAs will affect payments of Social Security taxes and the base for calculating benefits for new beneficiaries because it will affect the maximum amount of wages that are subject to Social Security, known as the taxable maximum. The Social Security Act specifies that the taxable maximum increases only in years in which a COLA occurs. Thus, under CBO's forecast, that maximum will be frozen until 2013. At that time, the contribution and benefit base will increases by the change in the national wage index since the last time a COLA was triggered. Following those current-law rules, CBO anticipates the base will hold steady at $106,800 for 2009 through 2012, and then jump to $118,200 in 2013, reflecting the cumulative change in the national wage index during the period of no COLAs.

Inflation has only very small effects on system financing; a failure to adjust the tax max would have somewhat larger effects.

For what it's worth, this aspect of the Social Security Act makes little sense. While I'm not particularly keen on raising the tax max, you want whatever rule is used for adjusting the cap to make policy sense. Adjusting the ceiling annually to maintain a constant percentage of total earnings subject to taxes makes sense to me; this would account not only for the growth of average wages but for changes in the distribution of earnings, such that if more earnings go toward the top then the cap would rise somewhat faster.


WilliamLarsen said...

Well that is something I did not know. There is also a problem with this statute. When the Maximum wage base does not increase, there is theoretically no increase in revenues, but wages could in fact rise, thus the "CBO anticipates the base will hold steady at $106,800 for 2009 through 2012, and then jump to $118,200 in 2013, reflecting the cumulative change in the national wage index during the period of no COLAs."Because the US average wage can increase, the monthly indexed wages subjected to the SS-OASI tax according to this will rise. The rise is 10.7% over this time frame. This means the initial benefits will be 10.7% larger for no increase in tax revenues, even though the base affects very few to begin with.

The entire purpose behind the 1977 change to calculating benefits is to make them the same between retiring cohorts relative to the US Average Wage at age 60.

Thanks for the information.

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James said...

I find it somewhat ironic that SS benefits are adjusted upward to reflect cost of living increases, but kept the same when cost of living actually decreases. In effect, the beneficiary comes out ahead in a version of "tails I win, heads you lose."

I understand the politics of this, but has anyone actually examined the additional cost to SS of this?

Andrew G. Biggs said...

I talked a little bit about this issue here:
I've done some computer simulations of how big the effects of this 'ratchet' might be, but unfortunately I'm out of the office today. There is a skewed distribution of outcomes from a random variation simulation, though, which is attributable to how negative inflation interacts with this provision in law.

Anonymous said...

Did i read your entry correctly, Andrew, that you favor a tax increase in order to maintain the share of total wages subject to taxation?

Won't tax increases tank the economy, make every rich person quit their job and move to Cayman Islands, and pretty much destroy the American way of life?

Forgive the snark, but I don;t remember your willingness to entertain tax increase in the past. And since you are willing ot entertain some tax increase, what is your criteria for how much you will tolerate?

Andrew G. Biggs said...

Anon: The governemnt can't run without taxes, and whatever tax policy you decide should be run as sensibly and non-arbitrarily as possible. I'm not one of these guys who says the world will come to an end if marginal rates rise by 1 percentage point. (Rising by 10 points, on the other hand, could be a problem.)