Is Wage Growth Really the Answer to Social Security’s Looming Insolvency?

New study bucks conventional wisdom that higher wages will save Social Security

December 10, 2007

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Long-accepted conventional wisdom has held that wage growth alone can improve the financial condition of Social Security — that it is possible to “grow our way out” of the program’s looming insolvency. According to a new study by the Cato Institute, the very premise on which this view is based is faulty — that, in fact, faster wage growth would worsen Social Security’s financial condition.

In “The Connection between Wage Growth and Social Security’s Financial Condition,” Cato Institute senior fellow Jagadeesh Gohkale finds that the impact of faster wage growth is an unsettled question, driven by the particular way in which Social Security’s finances are measured. Each of these indicators supports the view that faster economic growth – and faster wage growth in particular – would improve the system’s financing.

Unfortunately, asserts Gokhale, the measures used by the Social Security Administration to ascertain the program’s financial health are short-sighted, and hopelessly biased toward the conventionally accepted view that wage growth will “solve the insolvency,” a bias that creates a “garbage in, garbage out” scenario of cooked numbers and skewed data.

“Each [SSA] measure overemphasizes the positive impact of future wage growth on the program’s near-term revenues and de-emphasizes the, again positive, impact on future benefits,” writes Gokhale. “Because benefits are based on past wages, however, faster wage growth beginning today would cause benefits to increase only after a time-lag. Therefore, a short-horizon measure generally overstates the salutary impact of faster wage growth on Social Security’s finances.”

Still, the wage growth view of Social Security has long been advanced by both sides of the debate over the program’s future, which Gokhale contends is bad policy in service of political expediency – a Kabuki dance around the third rail of politics that offers soundbites, not solutions.

“The impact of faster wage growth on Social Security finances is theoretically ambiguous,” Gokhale concludes. “Under calibrations consistent with U.S. demographic and economic conditions, however, faster wage growth worsens Social Security’s financial condition when it is measured comprehensively.”

Cato Institute Policy Analysis No. 607