November 07, 2022
In mid-October, the Social Security Administration (SSA) announced various indexed adjustments for the operation of the program in 2023. Most attention was paid to a large cost of living adjustment (COLA) for benefit amounts tied to changes in the consumer price index. There was another large increase that is quite consequential but did not get as much attention despite the millions of taxpayers it will affect—the average wage index (AWI).
Among other things, the AWI determines the maximum earnings subject to Social Security payroll taxes, at a 12.4 percent rate. This so-called “tax max” increased from $147,000 to $160,200, an 8.9 percent increase, based on 2021 wage data. This is comparable to the COLA increase of 8.7 percent, which is unusual, because typically wage growth lags prices in an inflationary cycle. Indeed, in 2020, the COLA increase was 5.9 percent while the tax max increase was only 2.9 percent.
Wage data from the Bureau of Labor Statistics show much smaller wage increases in 2021—according to the employment cost index, wages increased 4.5 percent, and according to the Quarterly Census of Employment and Wages, average wages per employee increased 5.6 percent. Though there are data source differences and some definitional differences between SSA and BLS, the gap is large. What could explain it?
I posit that it is the stock market. Included in wages, especially at the top of the earnings distribution, are realizations of employee stock options. When the market is up, as it decidedly was in 2021 with a 27 percent increase, such realizations will grow noticeably in number and amount. One quite large and public example was the Tesla option realization of Elon Musk in 2021 of $23.5 billion. But the individual option realizations can be smaller—in the millions—and it will still add up and make a difference in the AWI. See Table 1, which shows the distribution of Social Security net compensation at the four top levels, for 2018 through 2021.
Source: Wage Statistics from SSA
The numbers, totals, and averages are generally fairly stable, with some modest growth in 2018 and 2019, and faster growth, especially at the top, in 2020. But 2021 sees substantial growth in numbers and totals, and at the top level in the average. If we were to recalculate the AWI for 2021 by just removing the increase from 2020 to 2021 in the average for the top compensation group, essentially removing the amount of Elon Musk’s option realization, the new tax max would be $159,600, an 8.6 percent increase. If we extended this adjustment to the top four groups, to get the same totals in 2021 as in 2020, the tax max would be $158,400, or an increase of 7.7 percent.
What are the implications of this analysis? For the SSA actuary doing projections of program finances, given the significant drop in the stock market in 2022, it means that one significant source of the frothy AWI growth has been removed for 2023 and beyond. For policy, it means that consideration should be given to changing the definition of the AWI, to avoid artificial volatility. Some have proposed using the median instead of the average. I prefer that wages from non-covered employment and above the tax max be excluded from total wages to reduce volatility. This is also logical because it makes the program internally consistent and self-contained—why should stock option realizations (like those of Elon Musk) which do not lead to Social Security benefits influence what millions of workers pay in Social Security taxes?