This piece by Brookings Nonresident Senior Fellow Robert Pozen was featured in the New York Times as one of a collection of recommendations of specific fixes that could be part of a comprehensive reform package for Social Security.
How do we maintain Social Security in the fairest way? Consider progressive indexing, which would preserve benefits for the bottom third of wage earners who rely on the program for almost all of their retirement income, but recalculate the benefits of higher-paid workers who have other sources of retirement income — including 401(k)s and IRAs — that are tax-subsidized by the federal government.
To calculate initial benefits at retirement, Social Security currently takes workers’ average career earnings and increases them by the rate at which average wages rose during their careers, a mechanism called wage indexing. Once workers start receiving benefits, they are increased annually by the amount that consumer prices rose in the prior year, called price indexing.
Under progressive indexing, by contrast, the initial benefits of the top earners would be calculated by price indexing, while the initial benefits for the bottom third would still be calculated by wage indexing (a grace period would be put in place for workers within three years of retirement). The initial benefits for the middle third would be calculated by a blend of price and wage indexing.
Progressive indexing would reduce the long-term Social Security deficit from $4.7 trillion to between $1.2 trillion and $1.7 trillion, depending on the design of the middle-income blend. Why? Because over the span of a worker’s career, wages tend to rise about 1 percent faster than prices.
In short, progressive indexing would preserve Social Security benefits for the neediest workers while allowing the benefits of other future retirees to grow at the rate of consumer prices or higher.