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'Tweak' in inflation formula or significant cut in Social Security benefits?

Rep. Nancy Pelosi, D-Calif., shares her reaction to the mass shooting in Newtown and talks about the future of gun control legislation in Washington, D.C.

President Barack Obama signaled during his first debate with his Republican opponent Mitt Romney on Oct. 3  that he was willing to consider a change in Social Security benefits.

He said, “It's going to have to be tweaked the way it was by Ronald Reagan and Speaker -- Democratic Speaker Tip O'Neill” in their 1983 deal that raised Social Security taxes and pushed up the eligibility age for collecting full retirement benefits from 65 to 67.

Now Obama has put forward his “tweak”: changing the formula used to increase Social Security benefits every year – a switch that would result in retirees getting a smaller increase in benefits than they would get under the current cost of living formula.

The average Social Security benefit for a retired worker is about $1,230 a month.

Beneficiaries will get a 1.7 percent increase in benefits, or a cost of living adjustment (COLA), in January to compensate them for the effects of rising prices. Beneficiaries got a 3.6 percent increase in 2012 but got no increase in 2011.

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Protesters rally in Florida against cutting Medicare/Social Security benefits.

The Social Security benefit increases are pegged to the consumer price index for urban wage earners, a measure called CPI-W, which is calculated by the Bureau of Labor Statistics. If prices drop, Social Security benefits do not get reduced.

Obama proposes to change to a different measure called “chained CPI” which attempts to reflect how consumers adjust their mix of purchases as the prices of different items change: for example, if the price of spaghetti was surging while the price of men’s shirts was unchanged, you might decide to buy somewhat less spaghetti and more shirts. You won’t stop buying spaghetti entirely and spend every last dollar on shirts, but you will adjust your consumer mix.

Jason Fichtner, the former chief economist of the Social Security Administration who now teaches at the Georgetown University Public Policy Institute, said the COLA which took effect in 2009 was a 5.8 percent increase using the current formula. If the chained CPI measure had been used, the increase would have been 5.2 percent.

On average, the difference between the current COLA and a COLA using chained CPI would be about three-tenths of a percentage point per year: so if under the current formula, beneficiaries would get a 1.5 percent increase in a given year, they’d get a 1.2 percent increase under a chained CPI formula.

“In times of high inflation, beneficiaries will still get a large increase; it just won’t be as much,” Fichtner said. “Everyone is still going to get a benefit increase -- both a nominal increase and a real increase to keep up their purchasing power.”

He added, “Depending on the measure of inflation you use, you can make the argument that we have been giving people a higher adjustment than is warranted, based on inflation and the change of consumer behavior to adjust to price. What this (chained CPI) does is just bring it back to a more realistic or accurate measure.”

Because there are so many Americans who collect Social Security benefits (56 million), because the number of recipients keeps growing by about 3 percent a year, and because Social Security is the single biggest spending item in the federal budget (more than one-fifth of all federal outlays), even a modest change – or “tweak” as Obama would say – would result in a significant reduction in spending.

Last year the Congressional Budget Office estimated that switching to the chained CPI formula for Social Security recipients would cut spending by $112 billion over 10 years (2012-2021).

If this switch in the COLA formula were applied to retired federal workers and to military retirees and their dependents it would save an additional $24 billion over ten years.

Obama’s proposed change would not be a cut in actual dollar terms in Social Security benefits – it would not mean a recipient who had been getting $1,230 a month would now get $1,150 a month. But some Social Security proponents still contend it will cause some hardship for some people. A calculation last year by the National Academy of Social Insurance found that a COLA that is 0.3 percentage points lower each year would result in a monthly benefit that was about 8.4 percent lower (than it would be under the current formula) by the time a retiree reached age 92.

In an analysis last year the CBO said, “An argument against reducing the COLA is that the prices faced by Social Security beneficiaries could rise faster than prices faced by the population at large. For example, beneficiaries are likely to spend more than younger people do for medical care, the price of which generally outpaces the prices of many other goods and services.”

Rep. Nancy Pelosi, D-Calif., talks about the latest in the fiscal cliff negotiations on Capitol Hill.

In an interview with NBC’s Andrea Mitchell Tuesday, House Democratic Leader Nancy Pelosi said, “the details of this are not all ironed out, but they all mitigate for helping the poorest and neediest in our society, whether they are SSI (Supplemental Security Income) recipients, whether they’re 80 and older or whether the truly needy in between.”

She said some statements by Democratic House members opposing Obama’s chained CPI proposal were not indicating total opposition, but opposition only if the final accord to be signed by the president did not provide exemptions for certain categories of the kind Pelosi mentioned.

But Eric Kingson, co-chairman of a group called Social Security Works and a professor at Syracuse University who served as an advisor to the 1982-83 Greenspan commission on Social Security Reform, said. “It’s a terrible idea. You can dress it up any way you want. It’s a benefit cut and it violates the promise that Leader Pelosi made, the president made, and almost every politician – Democrats and Republicans -- made that they would not cut Social Security benefits.”

He said the purpose of the COLA is to ensure that benefits maintain their purchasing power throughout your lifetime. He said for a beneficiary who retires at age 65 and reaches age 95, he or she will have lost $18,000 in benefits compared to what he’d get under the current system.

Kingson said he worked as a “very active volunteer” for Obama’s re-election and respects him, but “this is going to get an awful lot of people very upset…. It fosters a lot cynicism if we now move to cutting Social Security.” He said the Obama White House “probably doesn’t understand how critical this system is to regular Americans.”