Saving Retirement

CAMBRIDGE – Public pension programs around the world are in financial trouble. Because of continuing increases in life expectancy, the number of eligible retirees is rising more rapidly than the tax revenue available to finance benefits.

In the United States, the Congressional Budget Office projects the relative cost of the Social Security program’s old-age pension benefits to rise by more than a quarter over the next 25 years, from 4.9% of GDP today to 6.2% in 2038. Because the taxes that are earmarked to support Social Security do not automatically rise faster than GDP, either the growth rate of benefits must be reduced or tax rates must be increased.

One reason for the rapid rise in benefits stems from how they are adjusted for inflation. Under current US law, retirees’ benefits are automatically adjusted to account for increases in the traditional consumer price index (CPI). But experts have long understood that the CPI overstates the true increase in the cost of living, and that the resulting over-indexing of benefits should be fixed.

Part of the problem is that the CPI does not reflect how consumers change the composition of their purchases over time as relative prices change. President Barack Obama’s administration initially followed expert advice and suggested that the traditional CPI be replaced by a more accurate measure known as the chain-weighted CPI. Although this would reduce the annual rate of increase in benefits by only about 0.25%, outlays for Social Security and other inflation-indexed programs over the next ten years would be more than $200 billion lower. Applying the chain-weighted CPI to tax-bracket adjustments would raise more than $100 billion over the same period.