Linkmeister

Price versus wage indexing

In the great Social Security debate there's been some discussion of converting from wage-indexing to price-indexing. This is the best explanation I've seen so far:

Using the term "indexing" to describe what is being proposed creates confusion and makes a simple proposal seem complex, so let me try to clarify it.

Right now, Social Security benefits are based on an average of wages earned over a 35-year period. Over time, labor productivity has gone up. With more education and more or better machines, what each worker can produce in an hour's time increases. Thus, each worker produces more real output and our standard of living rises, assuming that our wages rise with productivity. If you contribute more to society’s output, you deserve more in return. This is how market economies are supposed to work, and did for most of the 20th century.

If productivity is rising by 3 percent a year, our standard of living should go up by 3 percent a year. But what if inflation was also 3 percent? If our wages rose by just 3 percent, we would not be able to purchase any more real output than the year before. So to correct for this, wages need to rise by 6 percent (3 percent for productivity and 3 percent for inflation). This is also what happened for most of the 20th century, except for a couple of periods in which wages did not keep up with inflation.

When the Bush administration proposes indexing benefits to price increases, what they are suggesting is stripping out the part of wage increases that result from productivity increases and only allowing for the increased caused by inflation. It is the equivalent of linking your retirement benefits to the very first job you take, rather the job you hold at retirement. It freezes your retirement standard of living at whatever the standard of living was when you entered the workforce.

According to the commission appointed by President Bush, if this "price indexing" approach is implemented, someone retiring 40 years from now would see their retirement income cut by half. They would receive only half of what they would receive if we left the system alone.