The Connection between Wage Growth and Social Security’s Financial Condition

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The conventional view that faster wagegrowth would improve Social Security's financialcondition rests on several measures of the program'sfinances that the Social Security trusteesemphasize in their annual reports. These measuresinclude annual cash-balance ratios, the 75-year actuarial deficit, the "crossover date," andthe "trust fund–exhaustion date." All of thesemeasures show that Social Security's financialcondition would improve if future wage growthwere faster. This conventional view also suggeststhat the trustees' relatively conservative assumptionsabout future wage growth cause the program'sfinancial imbalance to be overstated.

Unfortunately, the measures highlighted inthe trustees' annual reports have a short-termorientation that biases calculations towardshowing an improvement under faster wagegrowth. The connection between wage growthand Social Security's finances should be evaluatedusing measures that are free of a short-termbias. This Policy Analysis evaluates the connectionunder the more comprehensive infinitehorizon"fiscal imbalance" measure. It uses simplecases of the program's operation to explorethe impact of the relevant forces—populationaging, wage growth, discount rates, and the projectionhorizon. It shows that although fasterwage growth is desirable in and of itself toincrease general prosperity, it would likely worsenSocial Security's overall financial condition.By implication, a "do nothing" policy motivatedunder the conventional view would be diametricallyopposed to the correct perspective: Earlyreforms of Social Security should receive higherpriority under faster wage growth.

Jagadeesh Gokhale

Jagadeesh Gokhale is a senior fellow at the Cato Institute and one of the nation's leading economists. He is an expert on entitlement reform, labor productivity and compensation, U.S. fiscal policy, and the impact of fiscal policy on future generations.