The Agenda

Andrew Biggs on the Impact of Progressive COLA

While Social Security is a considerably less pressing issue than Medicare, it’s fiscal position has deteriorated in recent years. So I was reminded of Andrew Biggs’ brief discussion of the potential benefits of a progressive COLA reform on the program’s finances in his excellent essay on means-testing:

If we wish to balance the budget in the near term, the key is to devise approaches that generate targeted, immediate savings without imposing significant disincentives to work and save. In economic terms, we wish to impose a negative “income effect” — that is, a loss of income that individuals will seek to make up through additional work — without imposing a negative “substitution effect” that reduces the rewards to additional work.

Striking this balance will not be easy. If immediate reductions in Social Security and Medicare benefits are required, then the best option might be a combined approach: changing the benefit formula based on lifetime earnings so that the reform takes effect over the long term, but also implementing shorter-term changes that, while rooted in the same principle, are more incremental. For instance, we might pay wealthier individuals with higher Social Security benefits lower annual cost-of-living adjustments than those receiving lower benefits. A progressive COLA could reduce high-end benefits by reasonable amounts in the near term while generating incentives — not disincentives — to work or save. A policy in which the highest third of beneficiaries received no COLA, the lowest third received a full COLA, and the middle third received half the current COLA would reduce Social Security outlays by around 12% over the first ten years. In fact, the savings from this measure alone would be enough to balance the program’s finances over the long term. [Emphasis added]

The essay is primarily focused on the work disincentives created by means-testing, and how means-testing based on lifetime income might mitigate this effect. One hopes that right-of-center policymakers are reading this essay closely.


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