With the coming retirement of the baby boomers, in the next decade the federal government will take in less money in payroll taxes than it spends in social security payments.  Some argue the government planned for this contingency thirty years ago when they raised payroll taxes, taking in more revenue than it paid out and accumulating a large surplus.  The problem is the federal government, by law, had to invest the surplus in special government securities.  In other words, the one hand of government (the Social Security Administration) loaned the other hand of government (all other agencies) the surplus funds.  There is no Social Security surplus since all of it has been spent by the federal government.  In order for the SSA to redeem their government securities, the Treasury Department will either have to raise taxes, borrow additional funds, or print money—none of which are good options.

 

Below is a simple idea to create savings in the Social Security and the general budgets without a cut in spending or an increase in taxes.

 

Plan

The idea is to modify the way the federal government implements the cost-of-living adjustment (COLA) for Social Security recipients; retired federal workers; and current federal government employees.  

 

Under the current system, the federal government increases retiree’s social security payments by the growth in the Consumer Price Index (CPI) every January—based on the rise in the CPI between October and September of the previous year. 

 

The revised plan would measures the month-to-month change in the CPI and when it increases by five percent, the government gives COLAs of five percent to all of the groups covered.  If the CPI increases by more than five percent before twelve months have passed, the federal government would wait until the twelfth month and provide the COLA.  In other words, there would only be one COLA during a twelve month period.

 

Budget Savings

The table below shows a rough estimate of potential budget savings from the adoption of this plan.  The estimates assume the following:  1) the federal government spends $100 billion a month in Social Security benefits, pensions, and salaries to government workers; 2) the annual rate of inflation is three percent and the CPI increases by a uniform 0.25 percent each month; 3) and there are no changes in government spending other then the increases due the COLA.

 

The potential savings are likely higher because it does not take into account the rise in spending due to the coming retirement of the baby-boomers.  In addition, I assumed the government could implement the COLAs the month after the CPI increased 5%, any additional months needed to put the COLAs in place would add to the savings.

 

Cumulative Budget Savings of Proposal

(Billions of Dollars)

 

                          Five                  Ten               Twenty             Thirty

                         Years                Years             Years               Years

Current System          6,562.1            14,169.4          33,211.8          58,803.2

New Proposal             6,305.0            13,608.3          31,834.3          56,264.8

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Budget Savings             257.1                 565.6            1,377.5            2,538.4

 

Defense

Recipients still get COLAs equal to the rate of inflation.  The only difference is they don’t get them on a fixed annual basis (if inflation is such a problem for people then the federal government should provide monthly COLAs).  The added time between COLAs would not adversely affect recipients of government checks.  For instance, one of the components in the CPI is the cost of higher education, which has no impact of the vast majority of retirees.  As well, big ticket items included in the CPI like cars and dishwashers are not purchased on a yearly basis.

 

The reason for the savings is the fact that the annual COLA doesn’t just affect the budget in the year implemented.  It affects the budget of every subsequent as well.  The reason is when you put in a COLA in Y1 the next year’s COLA is not applied to the Y1 budget but to the Y2 one, which includes the Y1 COLA.  The COLA applied to the Y3 budget includes the Y1 and Y2 COLAs.  By delaying cost-of-living-adjustments even one month creates long-term budget savings.

 

As well, studies show the CPI likely overstates inflation due in part to the substitution affect.  BLS uses annual surveys of consumer expenditures to calculate the CPI, so it takes a year or so for them to adjust the index for the substitution effect.  This plan allows for the extra time to allow the CPI to represent the true rate of inflation.

 

One problem with this is if there is significant budget savings, it reduces the incentive for Congress and the president to make the needed fundamental changes to Social Security, like private accounts.