Sunday, May 01, 2005

Indexable Irony

Last week President Bush discussed a new Social Security reform proposal known as "progressive indexing", an innovative twist on an older proposal to replace the current wage-indexing with price-indexing. A little historical digression to help translate from the wonkese: It used to be that Social Security benefits were a set amount fixed in the law, and every few years Congress would have to amend the law to increase the benefit, to adjust it for increased cost of living. As one can imagine, there was much politics involved in bringing home that bacon term after term. About 20 years ago, Congress had the notion to include an automatic increase in the Social Security benefits determination, so that they wouldn't have to keep revisiting the issue every year and debating it. That automatic increase was tied ("indexed") to wage increases. Since historically wages have risen faster than prices (due to increases in productivity), the wage-indexed increases go beyond inflation and provide increased benefits to each successive annual cohort of retirees. Some have proposed reigning in the system by making the automatic increases pegged to prices rather than wages, which by itself may be sufficient to salvage the system. But others have cautioned that the differential between wage-indexing and price-indexing will grow without bound over time, so that over a long period, the Social Security benefit will replace substantially less of pre-retirement income. The innovative wrinkle suggested by Richard Pozen, and embraced by the President last week, offers a hybrid of the two, with wage-indexing for low-income earners progressively blending to pure price-indexing for high-income earners.

The ironic thing is that recently we've been in a bit of an economic eddy where prices have actually been increasing faster than wages. Looking at the recent CPI-U index, it increased 0.4% in February and 0.6% in March with a 4.3% annualized inflation rate based on the first quarter of 2005. Looking at average hourly earnings, on the other hand, they increased an anemic 0.06% in February and 0.25% in March with a 2.3% annualized increase in the first quarter. I'm not sure how long such a state of affairs would or could continue, but I certainly found it ironic that just as proposals are being made based on an assumption of wages increasing faster than prices, that assumption is upside-down, making "progressive" indexing actually regressive.

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