of time. Which one to adopt is far from obvious, and the choice hinges on important conceptual issues. The specific consequences of adopting wage indexing, both for retirees and the federal budget, would depend on the nature of the wage measure that was chosen and how that choice interacted with future economic developments. The initial choice of a wage index could itself be quite controversial, and the debate might recur in light of subsequent developments. However, subject to one qualification we discuss later, the wage measure could be estimated and social security benefits indexed without having to deal with vexing and often contentious issues involving the effects of substitution among goods and outlets, pervasive quality changes, and the introduction of new goods with which we wrestle throughout this report. We first describe the major conceptual alternatives for a wage index and then briefly summarize the pros and cons and the implications of using each of them.

The social security system already employs an aggregate national wage index as part of the process of calculating each retiree’s initial retirement benefit. That benefit is based on the annual earnings of the retiree in each past working year, indexed up to the date of retirement using an economy-wide “average annual wage.”5 The average is the mean of the annual money wages of employees as reported by all employers on their W-2 forms. It includes wages in excess of the social security taxable maximum but excludes nonmonetary fringe benefits.6 This average is also used to index the bend points in the benefits formula and the maximum earnings subject to tax. In implementing wage indexation, Congress might well decide that the same measure used to index preretirement wages for calculating the initial benefit ought simply to be extended through the retirement years, as the index for maintaining the relationship between postretirement benefits and the real wages of the working population.

However, this choice is not the only one for which a reasonable argument might be advanced. If the broad policy objective is to have the postretirement benefit rise or fall in line with the economic fortunes of the working population, a number of issues arise about the nature of the wage index that would do that appropriately. Perhaps the most important type of choice among alternative wage indexes involves an aggregation question that bears some resemblance to the issue of plutocratic versus democratic prices indexes: Should the index reflect the change in the mean wage or some other point in the wage distribution, the most likely candidate being the median wage? From the late 1970s to the mid-1990s,


Thus a worker’s earnings relative to other workers throughout her working life will determine the relative wage that enters into calculating the initial retirement benefit, but the absolute size of the benefit will also depend upon how fast average social security earnings have grown over time. (The formula that is applied to the resultant earnings measure to calculate benefits is itself highly redistributive.)


Some workers are not covered by the social security system, but an estimate of their wages is included in calculating the average social security wage.

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