This past Thursday, President George W. Bush, Privateer-in-Chief, finally deigned to put something "on the table" for his side of the privatization debate. The surprising part of this performance was that the president, for the first time, spoke directly on a proposal to actually address the phony "bankruptcy" "crisis" he has been drumming up non-stop for the last few months. (As regular readers know, his pet scheme to carve out one third of Social Security to create a private account does nothing to fix the projected shortfall in the system, and generally makes finances worse.)

For those of us geeks who follow these matters, "progressive price indexing" was no surprise at all. Banker Robert Pozen has been pushing this idea for several months. It is a very arcane change in an obscure formula, but it would have dramatic -- and disastrous -- effects that could lead to the decimation of social security insurance, as we will shortly explain. But first, by way of explanation, is an old conservative bugaboo.

MYTH: Social Security is welfare

[The Democratic Party] is unyielding in its defense of Social Security--a defense that rejects the idea of reducing by a penny the pension checks the government sends to Warren Buffett.... To make sense of this apparent contradiction is to make some sense of the ongoing debate over Social Security and the meaning of modern liberalism. One can begin by imagining a government program to prevent poverty among the aged, one that would be both simpler than Social Security and more aligned with liberals' desire to tax the rich and help the poor. It would derive its revenue from the progressive income tax rather than Social Security's regressive payroll tax. It would pay its benefits according to individual need. And for the majority of people who... are neither rich nor poor, it would devise incentives and requirements that would encourage them to provide secure retirements for themselves from pensions and savings. What's wrong with such an approach? Wilbur Cohen [said] "[A] program that is only for the poor--one that has nothing in it for the middle income and the upper income--is, in the long run, a program the American public won't support." In other words, people who don't need Social Security and Medicare are enrolled as beneficiaries for the sake of people who do.

... People have learned what liberal programs and rhetoric have taught--governments exist less to secure our unalienable natural rights than to deliver our unassailable public entitlements. (William Voegeli, "FDR's card trick," Wall Street Journal, 4/26/05; reprinted from "False security," Claremont Review of Books, Spring 2005)

REALITY

Mr. Voegeli, a research fellow at the Claremont Institute (alongside the embarrassing "Hindrocket" and friends from Power Line Blog), drones on at quite some length with his philosophical diatribe of what liberalism is. Shorter version: we want bigger and bigger government, because we're, um, confused about the failure of Marxism. I'll leave him to stew in his own nonsense, except to say that it is typical of fanatical anti-government types to latch on to Marxism as the one true enemy, which lets them criticize a liberal program, like Social Security or even a balanced budget, by attacking some nebulous tie-dyed hallucination of a "leftist," whatever that means, rather than the program's actual proponents in the reality-based community.

But Voegeli's article, timed a few days before a Bush press conference on "progressive price indexing," keys into an important part of the privatization debate -- a misunderstanding of what Social Security is. Usually, Privateers assume it is an "investment," so that they can attempt to show how private accounts would give better "returns." Of course it isn't an investment, as we've explained before. But at the same time, it is important to differentiate it from mere "welfare."

The defining characteristic of Social Security is that it is insurance. Whether our "nest egg" doesn't quite hatch (damn you, Pets.com!), or our employer's pension plan goes bust, Enron-style, or we're disabled through no fault of our own -- we face a number of factors that can undermine our best laid retirement plans. The American way of dealing with failure is to pick up and start again, but the problem we all have to worry about is when we just don't have the ability to support ourselves anymore. We all plan to live a long time, and we can also pretty much predict being bent over a cane at some point.

Hence, insurance. Everybody in America who works pays a premium, and in return we eliminate the risk of destitution when we are too old to work. Sure, we could "lose" by dying young or getting fabulously wealthy, or we could "win" by reaching 70 without a penny to our name -- we just don't know when we start working where we'll be at the end of the line.

Similarly, one can look at the millions of seniors being kept out of poverty by Social Security and call it a a poverty program or a welfare program, but that description doesn't cut it either. Sure, it does wonders to help our society's welfare by keeping many seniors from the soup lines, but it functions primarily to benefit individuals by fulfilling the bedrock component of retirement planning. The guarantee of adequate income from Social Security is irreplaceable -- no private system can provide it.

Voegeli believes that applying a means test to Social Security to cut benefits on wealthy seniors would throw a wrench into the works by making it transparently a welfare program. He may be right that Americans would lose interest in such a scheme, seeing as how it would lose characteristics that make the program not only necessary but universally smart.

Our president, in a not-so-dramatic prime-time press conference on Thursday, unveiled his support for a similar but different benefit cut plan to complement his across-the-board carve-out. "Progressive price indexing" shares the negative aspect of means testing, while adding on even more bad ideas.

First, an explanation. If the exciting world of pension accounting makes you drowsy, or if you plan on operating heavy machinery, you might want to close your eyes...

Price indexing is nothing new -- it is the only part of Bush's model (the Presidential Commission's Plan 2) to address the system's solvency. As most people know, retiree's benefits are adjusted each year to keep up with inflation (the cost-of-living adjustment, or COLA). But when a worker enters retirement and their benefits are calculated out based on their earning history (and contribution into the system), Social Security uses a (very complicated) formula that determines the replacement rate -- what proportion of your working income will be matched by retirement income. Because Social Security focuses on adequacy, this benefit formula is progressive, and the lower end of the worker's income is replaced at a much higher rate than any income on top of that.

For example, someone retiring this year will get benefits equal to 90% of their first $7,500, then 32% of their next $38,000, and then 15% of the rest (up to the payroll tax cap of $90,000). This calculation happens once, on retirement, followed by annual inflation adjustments (COLAs).

These numbers, of course, are not fixed in stone -- they go up every year, just like the poverty level and the median income. The key to calculating these "bend points," as they are opaquely called, is the average wage index. The bend points rise at the same rate the average wage rises. Thus, as wages rise, so rise benefits, in a convoluted way. I'm sure it makes perfect sense to actuaries.

That's what they mean by "wage indexing." "Price indexing," on the other hand, keeps those bend points down to inflation levels, which have always been much lower than wage growth. In other words, more and more income creeps into the upper bends of low replacement -- and this Congressional Budget Office analysis shows how the replacement rate under price indexing, as it gets worse and worse, actually amounts to a much bigger cut for all income levels than if the system remains untouched. (Compare the second and third columns.) See also this explanation by Adam O'Neill.

OK, you can open your eyes now. Short version -- so-called "price indexing" amounts to a large cut in benefits by ignoring changes in the standard of living (flush toilets and other innovations) across a lifetime of working. "Progressive price indexing," as proposed by Bush on Thursday, is an attempt to spit-shine the idea by adding the word "progressive." Basically, wage indexing (factoring the standard of living over one's working lifetime) would be kept only for the poor -- everyone else would take a dive.

Without factoring in private accounts -- which carve out a significant part of the defined benefit -- these future benefits will not technically be lower than today's benefits. But, as the Washington Post points out, that is the case also if no change is made to the system: "If nothing is done to Social Security, the system will be able to meet the president's promise to ensure that all seniors receive a benefit larger than current levels."

There are two fundamental flaws with this idea. First, progressive price indexing (let's call it PPI), like price indexing, does worse when the economy does better. As this feature has pointed out many times, the projections of the Social Security Trustees that lead to a shortfall actually presume a very dire future. For example, they think our economy will grow at only 1.8% a year -- though we have average 3.5% since 1950. So if nothing is done, and all the pessimistic assumptions come true, benefits will be cut 20 or 30 percent, while remaining above current levels. (For an average worker under PPI, cuts will deepen over time, from 21% for someone retiring in 2045 to 28% for some retiring in 2075, and so on.)

But if the economy does better than projected -- as it always has -- doing nothing will give us the benefits we expect. Just 2.2% growth (half the rate of 2004) would keep us in gravy, for example, as would six more years of 3.5% growth at any time in the next 40 years.

Progressive price indexing, on the contrary, would make deeper cuts if the economy does better.

For example, the Social Security actuaries project that real wage growth will average 1.1 percent annually.  If real wage growth turns out to average 1.6 percent annually, the benefit cuts under progressive price indexing would be considerably larger than the benefit reductions described above.  For example, under the Trustees’ assumptions of 1.1 percent real wage growth, an average-wage earner retiring in 2075 would get a 28 percent benefit reduction under progressive price indexing (relative to the benefits that would be provided under the current benefit structure).  If real wage growth were 1.6 percent, this worker would be subject to a 35 percent benefit reduction. (Center for Budget and Policy Priorities, 4/29)

So PPI, compared with doing nothing at all, makes cuts as large (and getting larger) for all workers except the poor, while only covering about 70% of the projected pessimistic shortfall -- and if the economy grows a little better, the cuts become deeper. Basically, it's a bad deal.

The second fundamental flaw with PPI is that it brings Social Security into the realm spoken of by William Voegeli -- that of welfare. Over time, the cuts deepen to the extent that benefits would become practically flat in a hundred years. Any earning above the low end would almost not be reflected in benefits at all. Once private accounts are factored in (one third of Social Security contributions, clawed back at 3%) and the Medicare premium (automatically withheld), millions of retirees would get a Social Security check of zero. They would be left, instead, with whatever plans they may have made on their own, plus their George W. Bush private account.

The problem with this is that it eliminates the guarantee of adequate income -- instead, for middle and higher income workers, the private account clawback would eat up the entirety of the defined benefit, without guaranteeing any particular result from the private account, which is only one-third of the traditional system to begin with. Not only would the PRA have to match the 3% clawback rate, it would have to triple in size to reach the traditional promised benefit.

So PPI combined with the private account would effectively eliminate the insurance character of Social Security. It would create a truly bad deal for almost everybody, by gutting Social Security of its essense. Who would want such a crappy program around?

It's amazing how a "small" one-third carve-out, as Bush's PRA plan proposes, can so easily destroy the most popular government program in history. That it costs so much (five trillion dollars in the first 20 years of PRAs) and gives so much less to most of us should make us all stop and realize how big a bunch of idiots Privateers must take us to be.