To: Dr.

Christina Romer

From: Tarun Singh

Re: Meetings with Critics of the President’s Stabilization Policy

Source: Congressional Budget Office

Issue:

According to the Congressional Budget Office (CBO), Social Security is expected to

have outlays greater than revenues by 2019 and will be unable to pay benefits in full by 2049

(See Figure 1 above). This memo evaluates the impact of reducing Social Security benefits

through the following three options:

1. A 25% cut in all benefits

2. An increase in the normal retirement age from 67 to 72 and in the early retirement

age to 70

3. The elimination of inflation indexing

A 25% cut in all benefits:

Arguments For:
 • The CBO estimates that by cutting PIA by 20% in the year 2012 will delay Social

Security revenues falling below outlays to 2028 and will prevent an exhaustion of the

fund.

o Cutting benefits by 25% by 2015 would only magnify this effect.

Arguments Against:

• Although reducing benefits by 25% does make Social Security solvent in the short run,

Feldstein argues that the solvency problem is caused by both an increase in the number of

retirees, due to the baby boom, and due to increased longevity.

o Cutting benefits does not address the long term problem of increased longevity,

meaning further reforms to the system will be required in the future

Impact:

• Those close to retirement will be impacted heavily as they will have little time to adjust

savings in response to this benefit cut, whereas those further from retirement will have

more time to increase savings and smooth consumption.

• Feldstein notes that individuals for whom Social Security payments make up more than

50% of after tax pre-retirement income are less inclined to save for old age.

o Reducing benefits means lower income individuals will be incentivized to save

more since Social Security payments will be a lower percentage of after tax pre-

retirement income.

An increase in the normal retirement age from 67 to 72 and in the early retirement age to

70:

Arguments For:
 • Peterson and Howe point out that if Americans retired at age 72 they could expect to live in

retirement as long as Americans who retired at age 65 in the 1940’s .

• According to the Congressional Budget Office, eliminating the NRA hiatus to 67 and

continuing to increase the NRA by two months per year to age 70, so the NRA reaches

70 for beneficiaries turning 62 in 2029 would help delay the trust fund exhaustion to

2089.

o Increasing NRA to 72 and the early retirement age (ERA) to 70 by 2015 would

only delay the exhaustion of the fund further and may even prevent an exhaustion.

Arguments Against:

• Raising the NRA and ERA to 72 and 70 respectively only solves the issue of solvency in

the short term.

o In order to keep Social Security solvent in the long run, you would need to not

only increase NRA and ERA but also index them to life expectancy since life

expectancy will continue to rise according to a report by NBC.

Impact:

• According to the Brookings Institute increasing both NRA and ERA would lead to an

increase in labor force participation amongst the older population.

• Younger workers will be able to adjust savings to smooth consumption as a result of an

increase in NRA and ERA but older workers closer to retirement will not have the same

ability to smooth consumption.

• Low income workers tend to work more physically demanding jobs, as a result it may be

impractical to expect low income workers to delay retirement until 72.

 o Low income workers are also the individuals that would be more reliant on social

security as a primary source of income in retirement.

The elimination of inflation indexing

Arguments For:

• The government doesn’t invest Social Security revenues and therefore the revenues do

not grow with inflation but outlays do, this means that in order for revenues to match

outlays either inflation indexing has to decrease or revenues have to increase through

higher taxes and higher taxes would increase dead weight loss.

Arguments Against:

• Forcing individuals to invest in a program that is not indexed for inflation increases their

losses considering the individual could get better returns by saving themselves in a

mutual fund or even in inflation indexed treasury bonds.

Impact:

• Abolishing inflation indexing will lead to more people retiring early as the real value of

the money they have contributed to Social Security will decrease as long as inflation is

greater than 0.

o This will lead to a decrease in labor supply

• This proposal would also be particularly hard on lower income workers who are already

retired as the lack of inflation indexing would push them into the bottom rungs of the

economic distribution.
 Works Cited

Gregory, David. "Why not raise retirement age?." NBC News 3 May 2005 Web.26 Apr 2009.

<http://www.msnbc.msn.com/id/7725312/>.

Feldstein, Martin. "Rethinking Social Insurance." American Economic Review Vol. 95 No. 1

(March 2005): Print

"Increasing the Eligibility Age for Social Security Pensions." Brookings Institute 15 July 1998

Peterson, Peter, and Neil Howe. On borrowed time: how the growth in entitlement spending

threatens America's future. Transaction Publishers, 2004. Print.

"Projected Effects of Various Provisions on Social Security’s Financial and Distributional

Outcomes." 25 May 2005. Congressional Budget Office. 25 Apr 2009

"Updated Long-Term Projections for Social Security." Aug 2008. Congressional Budget Office.

26 Apr 2009