The effects of wage indexing on social security disability benefits.

Summary and Introduction Economists David Autor and Mark Duggan have hypothesized that the Social Security Administration's (SSA's) use of the average wage index (AWI) in its benefit formula, coupled with a widening distribution of income, have created an implicit rise in replacement rates for low-earner disability beneficiaries. They point out that the actual disability benefit received depends implicitly on the individual's earnings growth relative to the growth of earnings for all workers over the benefit calculation period. This article examines the effect that indexing using the AWI has had on Social Security benefits. To the extent possible, the article tests the Autor and Duggan hypothesis and attempts to quantify the earnings history and bracket effects using actual earnings histories of disability-insured workers. Whereas Autor and Duggan used earnings at certain percentiles of the earnings distribution to demonstrate the potential effect, this article uses actual earnings histories of disability-insured workers to estimate the benefit and replacement rates that each worker would have received if he or she became disabled over the period 1979 to 2004 and to determine if these are, in fact, rising. This article demonstrates that the distribution of Social Security-reported annual earnings is widening, with the highest earners receiving larger increases. Hence, the AWI may overstate growth for lower earners. Using the Continuous Work History Sample, the article shows that over time replacement rates for many workers have been increasing relative to recent earnings and, as a result, may be increasing incentives to seek disability benefits. In an alternate approach, a different, more representative index of earnings growth for the majority of workers is used to create a counterfactual, permitting the decomposition of replacement rate changes into the "earnings history" and "bracket" effects identified by Autor and Duggan. Results suggest that both effects have led to higher replacement rates, but the bracket effect appears to contribute most to the trend. Direct comparisons are made between the results from this article, using actual earnings histories, and those obtained in Autor and Duggan's 2006 article. Finally, this article analyzes the potential impact of using alternative methods of indexing on benefits, replacement rates, and program solvency. For example, an index based on median earnings growth could help solvency not only for the disability program, but for the retirement program as well. The analysis suggests that progressive indexing could exacerbate problems with incentives to seek benefits and result in a less efficient solution to long-term solvency issues. Tables presenting detailed data underlying the charts in this article are available as Appendices B and C at http://www.socialsecurity.gov/ policy/docs/ssb/v68n3/v68n3p1_app.html. These tables may also be requested in hard copy from the author: L.Scott.Muller@ssa.gov. Background In the early years of Social Security, the benefit calculation was static, with Congress legislatively granting ad hoc increases in benefits to account for increases in the cost of living or for other reasons. In 1972, Congress passed legislation that provided for automatic annual cost-of-living adjustments (COLAs) to benefits based on the Consumer Price Index (CPI). The first annual COLA for Social Security benefits occurred in June 1975. Adjustments were made to the benefit formula by increasing the percentage of the average monthly wage (AMW) applicable to the primary insurance amount (PIA) at each bend point in the formula. As the taxable maximum increased each year, an additional bend point was also added to the formula. Before long it became apparent that this method of adjustment resulted not only in higher benefits, but also in higher real benefits for successive cohorts. Inflation increased not only the cost of living and hence the CPI, but generally resulted in higher earnings as well. …