President Obama's budget, unveiled today, proposes to cut Social Security benefits by changing the formula used to calculate annual cost-of-living adjustments (COLA). This is a bad idea masquerading as a painless technocratic correction.
The specific proposal is to calculate cost-of-living adjustments (COLAs) based not on the CPI-W (consumer price index for urban wage earners and clerical workers) but on a different price index that takes tries to take into account the extent to which consumers change their purchasing behavior from higher-priced goods to lower-priced goods. This would probably reduce the annual COLA by about 0.2-0.3 percentage points, thereby reducing federal government outlays on Social Security benefits. The sneaky thing about the proposal is that it can be defended on reasonable-sounding grounds: since some economists think that chained CPI is a better measure of true inflation than the ordinary versions of the CPI, it can be framed as simply reducing COLAs to what they should have been anyway.
There are a number of problems with this proposal, including the fact that the real cost of living for the elderly probably increases faster than the CPI-W, since the elderly consume a disproportionate amount of health care, which has a higher inflation rate than the overall economy.*
More generally, you don't actually save any money by reducing Social Security checks. There's no "waste" in Social Security. It's a program in which one set of people pays cash to the government and the government pays virtually all of that cash back out to another set of people. Every dollar in lower benefits is one dollar less in someone's wallet.
A Horrible Idea Whose Time Has (Apparently) Come
There are a number of ways to look at this. Many of the people supporting lower Social Security benefits would vehemently oppose higher taxes. Let's say I propose a new tax, at a rate of 0.3 percent of income for each year that the taxpayer lives beyond the age of 67, so a 77-year-old person would pay 3 percent. That tax would do roughly the same thing as switching to the chained CPI, since, for most elderly people, Social Security is most of their income. My proposed tax would be immediately laughed off, even if I tried to argue that it simply corrects for "excessive" COLAs. The point is that cash is cash. Framing it as a technical correction doesn't change the fact that the older you are, the less money you'll get. And calling it a reduction in "wasteful" government spending doesn't mean that the total number of dollars available to people will magically go up.
There are things the government does that produce social benefits out of all proportion to their budgetary cost, like basic research. There are things it does that are tremendous wastes of our money, like invading countries that pose no threat to us. And there are things whose benefits are roughly equal to their costs, like Social Security. If we want to reduce government spending, we should look for the second category of expenditures. The government is just a tool that we use to do things that are difficult for us to do as individuals. In the case of Social Security, cutting government spending for the sake of cutting government spending--and ignoring the fact that those spending cuts come dollar for dollar out of our own pockets--reflects a senseless fetishization of the federal government (typically by people who insist that they care about individuals, not the federal government).
If Anything, Social Security Should Be Bigger
Now we could have an argument about whether, at the margin, Social Security is a net negative or a net positive from an economic standpoint. On the negative side, it is a forced savings program, meaning that people do not have full control over their money, meaning it distorts economic choices. On the positive side, it is an insurance program that provides valuable protection to people of all ages against the risks of not making a lot of money or outliving your savings, and for this type of insurance program to work, mandatory participation is essential. Social Security may look like a naked tax-and-transfer program when you look at it in retrospect, after you know how everyone's life turned out. But if you look at it from the perspective of a new college graduate and compare expected contributions to expected benefits, it looks a lot more like insurance you want but can't get anywhere else.
Beyond the general pointlessness of "saving" money by taking it out of retirees' wallets, cutting Social Security is absolutely the wrong thing to do right now. I recently attended a conference on retirement savings and defined contribution plans at the University of Connecticut Insurance Law Center, and the overwhelming consensus was that most Americans are deeply underprepared for retirement, in part because 401(k) plans simply do not do the job.
In this bleak landscape, Social Security is the only source of retirement income that offers any hope for many people. As of 2010, the present value of Social Security benefits made up over 60 percent of the financial assets of typical households on the verge of retirement (including both defined contribution and other defined benefit plans). But Social Security benefits, in real terms, are getting smaller. By 2030, the take-home income replacement rate offered by Social Security will be less than 80 percent of what it was in 2002--thanks to a higher full-benefit age, increasing Medicare Part B premiums, and rising taxes on benefits (because of a non-indexed income threshold).
In short, at a time when many Americans depend on Social Security and Social Security benefits are already falling, Barack Obama wants to make them even smaller. Politically, as part of his eternal quest for the Holy Grail of compromise, it may make sense. But it's the wrong thing for the American people.
* No, Medicare doesn't solve this problem. Medicare has higher cost sharing than most private insurance plans, and even retirees with Medigap supplemental insurance will feel health care inflation in their premiums.>