Changes in Entitlements Needed

The Valley Industry and Commerce Assn.’s federal issues committee recently spent a whole meeting trying to decide whether to support the Boskin Commission’s recommendations regarding the consumer price index. This blue-ribbon panel, appointed by the Senate Finance Committee, suggested that the old method of calculating the CPI overstates the real change in prices by about 1.1%.

Whether or not it’s overstated is vitally important because the CPI is used to determine cost-of-living increases. Its calculation affects increases in rents, Social Security payments, and all sorts of price levels that change as the CPI changes.

VICA concluded that the formula does, indeed, need to be changed, and that the change would positively affect the federal deficit. The committee took the position that the changes should be realistic and should be made as soon as possible.

The technical debate, although important, is not as important as the psychological debate. The president and Congress cannot relax once this change is made and assume that the CPI will take care of our deficits. Much more needs to be done, particularly in the entitlements arena. This is why VICA has also taken positions strongly supporting legislative momentum designed to protect the long-term solvency of federal entitlements.

*

The situations of two fictitious San Fernando Valley residents help explain the problem and why VICA took the positions it did. Matthew and Barbara, as two extremes of the Valley area’s more than 186,000 senior citizens, should feel completely different about the potential change in the CPI. They don’t. Each thinks it makes sense--but for different reasons.

Barbara, a widow, is barely making it. She lives in an apartment in Reseda and has an annual income of about $30,000, including about $8,000 from Social Security.

The CPI is used to determine how much her Social Security payments will increase each year. If the CPI were reduced by 1.1%, her next-year increase would be about $7.30 a month less than it would be without the adjustment. To most people, that is not much money, but to Barbara it is quite important, yet she is willing to live with the change.

Barbara knows what is in store for her children and grandchildren in the year 2030. By that time, the average annual Social Security check will go from the current $7,995 to about $37,000. The CPI change would reduce that amount to about $25,000.

*

Barbara knows that in 2030 there will be 25 million more retirees than there are now, and that the current ratio of workers to retirees will go from 3 to 1 to 2 to 1. She understands that unless changes are made now, when they are relatively easy, excruciatingly difficult ones will need to be made later. If changes are not made, her grandchildren will have to pay FICA taxes of 35% to 50%, and there is no way they will be able to afford it. So she is willing to lose an increase of $7.30 a month now to help her children and her grandchildren in the future.

The CPI adjustment would cost Matthew $140 a year. No big deal. Matthew and his wife, Judy, live in Encino in a house that is paid for. Their annual income is about $100,000, including $14,000 from Social Security. They did everything they could to ensure a comfortable retirement, by participating in company pension plans, saving constantly and wisely investing. Like Barbara, they understand the problems their children and grandchildren will face. They are willing to do even more to help them later.

One thing they think is a good idea is the entitlements affluence test recommended by Peter Peterson in his book “Will America Grow Up Before It Grows Old?” (Random House). Peterson, chief executive of the Blackstone Group and president of the respected Concord Coalition, a nonpartisan economic policy group, has long been thought of as the Pied Piper of entitlements, leading the charge to save programs such as Social Security and Medicare.

He suggests that all entitlements, including Social Security, the insurance cost of Medicare, farm subsidies, unemployment payments and federal pensions, be lumped together and an affluence test applied. Peterson would eliminate people with income of $40,000 or less from the affluence test and therefore provide a protective shell for America’s neediest. For every $10,000 of income over $40,000, he would take away 10% of the entitlements received. There would be a maximum reduction of 85%, so that even the most affluent would still receive a modest tax-free income on their past FICA contributions.

This would mean Matthew’s Social Security payment would be reduced by 60% or $8,400 annually. Although the loss of $700 a month is no chump change, Matthew would still have more than enough and is willing to give up that income to help his kids and grandkids.

In addition to being simple, the Peterson proposal is progressive. It puts a large part of the burden for saving Social Security on middle- and upper-income people. This is fair because a large share of entitlements now goes to middle- and upper-income Americans. The savings would compound as the population ages and the number of beneficiaries grows. By 2000, the total annual entitlement savings under this affluence test would be about $70 billion. By 2020 it would be $220 billion, and by 2040, more than $550 billion.

*

A change in the CPI will happen, and it will help. But it will not be enough to save entitlements.

The demographic pressure caused by baby boomers (those born between 1946 and 1964), added to increased life expectancy, requires structural changes such as an affluence test, and not just quick fixes such as reducing the CPI.

Making these changes now is relatively painless. Waiting could be a disaster.