4 Key Retiree Issues in Budget Deal

Congress and the White House get closer to a deal before the U.S. faces debt defaults in early August.

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With government debt defaults looming just three weeks away, the prospect of major changes in senior spending and safety-net programs is the greatest it's been in decades. The final form of any changes is still to be determined. But there are several aspects of possible spending and tax changes that are especially important to seniors.

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First off, some broad points need to be made. One is that there appear to be no "done deals" here. It is still very much trial balloon time in Washington. Is the "big deal" still a possibility? Or will we end up with a "small ball" approach, with large but not game-changing spending cuts? If it's the latter, how will world markets react?

Beyond the polemics, few people have paid a lot of attention to the plain truth that it will be impossible to make significant changes to the government's largest spending and entitlement programs in only three weeks. These are fiscal supertankers, and you can't turn them around quickly. Making major changes to Medicare, Medicaid, and Social Security are complex processes that require thorough deliberation.

The most feasible outcome in the next few weeks would be a binding agreement that is acceptable to the White House, Senate, and House of Representatives. It would set forth the amounts of spending cuts and, perhaps, revenue enhancements that are judged sufficient to convince a Congressional majority to raise the nation's debt ceiling. Binding agreements have been no match in the past for creative legislators. No one has explained why things should be different this time around.

Further complicating the deficit discussions is the economy, which has very inconveniently declined to participate in the recovery. Consumer demand has not picked up. Companies are sitting on huge hoards of cash but are reluctant to hire workers until demand recovers. Last Friday's unemployment report would have been good news if the nation in question had been Greece. In the United States, it was a disastrous sign of long-term malaise.

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The jobs report also hardened the battle lines in the debt ceiling drama. Liberals cited the report as evidence that more stimulus is needed. Conservatives were equally assured the report illustrated that federal policies—too much spending, too much regulation, and too much uncertainty—were hurting the economy. Meanwhile, the government's fiscal stimulus efforts are winding down, and it's clear they have supported lots of jobs, particularly in state and local government.

With that said, the clock will be ticking more loudly in the coming weeks. Here are four key items that seniors should have on their fiscal scorecards:

Cost of living. Annual benefit changes tied to inflation are very important to Social Security recipients. Changes in consumer prices also play a big role in annual adjustments to Medicare insurance premiums. And they are widely used to set annual changes in tax deductions and many other federal programs. Inflation, however, can very much be in the eye of the beholder.

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The measures of consumer price changes used in current benefit calculations are more expensive than another measure that is gaining favor. It's called the "chained" consumer price index. Briefly described, traditional CPI measures track the same items over time. If beef becomes more expensive, the CPI rises. However, in the real world where consumers live, rises in beef prices cause many consumers to buy less red meat and more cuts of less expensive meat.

The traditional CPI thus may overstate the impact of rising prices on overall living costs. The chained CPI takes these substitution actions into account. So it rises less than other price measures. And if it were used to set annual cost of living adjustments in federal programs, expenses would fall by a lot.

Not surprisingly, senior groups aren't fans of the chained CPI. They argue that the current COLA has understated real price increases for seniors, particularly when it comes to prescription drugs and other healthcare costs. The chained CPI would be even worse.

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Means Testing. Attaching benefits levels to measures of income and wealth has long been a popular method of reining in entitlements costs without punishing lower-income Americans. Besides, well-off Americans will do just fine with a smaller handout from Uncle Sam, the reasoning goes. Don't be surprised to see lower benefits and higher taxes (sorry, I mean revenue enhancements) for wealthier Americans in any number of program changes.

Medicare benefits could be capped for wealthier people. The size of some tax benefits could be similarly capped. The most commonly advocated reduction is the current $1.1 million ceiling for mortgages eligible for the interest-deduction expense on federal taxes. Cutting it to $500,000 and restricting it to the taxpayer's primary residence has been widely advocated.

Social Security payroll taxes. There is a lot of support for extending the 2 percent cut in the employee payroll tax for Social Security, which has reduced the employee tab for Social Security to 4.2 percent of payroll, up to annual earnings of $106,800 a year. Weak job markets have prompted support for cutting the employer share of the tax by 2 percentage points as well. These increases would be only for a single year and would lapse at the same time as the extension of the Bush cuts in income tax rates. Then, depending on 2012 election results, expect another huge tax fight.

Twitter: @PhilMoeller