The centerpiece of President Bush’s Social Security reform plan is no longer personal accounts. It’s something called progressive price indexing.

Progressive price indexing involves not the cost-of-living adjustment (COLA) that retirees receive each year, but the basic formula that calculates benefits upon retirement. Today that formula increases the future benefits to be paid to workers upon retirement by the rate of growth of wages each year. Under a basic price-indexing scheme, that would be changed so that benefits increase only at the rate of growth of prices, or inflation. Under “progressive” price indexing, which has been proposed by Wall Street Democrat Robert Pozen, workers making under $25,000 a year would be subject to wage indexing and workers making over $113,000 would be subject to full price indexing. Those with salaries falling in between would be subject to progressive price indexing as their incomes rise.

The folks selling this idea argue that the current wage-indexing system increases benefits for future retirees each year in real terms, above inflation, which is unworkable since all projections show that Social Security doesn’t have the financing to pay such benefits over the long run. But the problem with this reasoning is that taxes paid under the payroll tax rise with wages each year as well. If taxes grow faster than benefits, than the effective rate of return promised by the program would decline each and every year — into perpetuity.

Under the current wage-indexed system, Social Security already offers workers low, well-below-market returns. For most workers currently in the system, the real rate of return promised by the program is 1 percent to 1.5 percent or less. For some it is zero, or even negative. But price indexing would drive more and more workers into this negative-return range, making the program harsh, oppressive, and senseless for many Americans. Some workers would be paying $10,000 to $15,000 per year into the program, while reaping a greater negative return on that money each year. Across their careers, price-indexed workers would see their future promised benefits cut by about 40 percent from current levels.

Stocks, meanwhile, pay a long-run real rate of return of over 7 percent.

The Social Security problem today can be defined as follows: “If something isn’t done, by the time today’s young workers retire there will only be enough revenue to pay two thirds of promised benefits.” The price-indexing solution says, “Not to worry. We will change the basic benefit formula so that by the time today’s young workers retire Social Security will only pay them two-thirds of the currently promised benefits.”

Is that a solution, or is that really part of the problem we should be trying to solve?

Under progressive price indexing, all workers making over $25,000 eventually reach the same point as higher-income workers. They just get there later. Plus, the system acts as an effective tax on rising incomes: It takes away benefits faster for those who earn more. This has the same negative economic effects as a marginal tax-rate increase.

Speaking of taxes, another problem with progressive price indexing is that it inevitably requires a tax increase. Democrats and liberals are never going to agree on a plan that addresses the Social Security deficit entirely with benefit cuts. They are going to insist that at least half the gap be closed with tax increases — a “balanced plan,” as the AARP is already calling it.

One idea being loudly discussed is an increase in the maximum taxable annual income for the payroll tax, which is currently set at $94,200 per year. That cap is already indexed to grow each year with wages, but the proposed increase would raise it in one leap to between $125,000 and $150,000, with the wage-indexed increases to continue thereafter.

Workers in this income range would pay as much as $7,000 per year more in Social Security taxes. This would especially hurt small businesses and the self-employed who pay both the employee and employer shares of the tax directly.

The top marginal tax rate would be raised by 12.4 percentage points, which is the total Social Security payroll tax rate, more than offsetting the Bush income-tax cuts. This would retard the economy and produce less tax revenue than expected.

The maximum annual taxable income limit is not some loophole for the rich. Workers who do not pay taxes on income over the limit also do not receive benefits for income over the limit. If the taxable limit is raised, more income will be counted towards future benefits as well, leaving little net gain over the long run.

What sense does it make to require these workers to pay more into the program for a negative real return?

Finally, there is the idea of add-on accounts on top of Social Security, with the government funding contributions for low- and moderate-income workers.

Real personal accounts involve substituting market savings and investment in the accounts for some of the benefits under the current system. Such personal accounts would produce dramatic reductions in big government and the long-term burden of public entitlement spending. But add-on accounts involve no change in the current Social Security system at all. Government funding for these accounts on top of the current Social Security system equates with an expansion of big government rather than a reduction. Indeed, it would effectively add a new entitlement program to the already woefully over-promised entitlements that threaten to swamp Americans with big-government spending for the next generation.

The Washington establishment is already signaling it would love a deal with these three components. And that’s because it leaves the current Social Security system entirely intact while defeating those personal-account reformers who seek fundamental change. But it is a bad deal for working people, conservatives, Republicans, and free-market advocates — no small constituency.

A political revolution in Congress is not necessary for the passage of real personal accounts. What is needed is a leader, someone to propose and fight for a positive, even populist, personal-accounts reform plan that benefits working people without taxing them more or cutting their benefits. With such a plan, the President can go over the heads of the Washington establishment and speak directly to the people. That was the Reagan way, and it worked time and again.

Conservatives on the Hill are developing a new bill along these lines as an alternative to any Bush/Democrat tax-increase plan. The president should spend his next two years promoting such Social Security positivism to the public, so that true reform can be passed under the next president. Conservatives, meanwhile, should remember that there is no substitute for victory.

– Peter Ferrara is a senior fellow at the Free Enterprise Fund and is director of entitlement and budget policy for the Institute for Policy Innovation. He also serves as general counsel for the American Civil Rights Union.