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The Solution: Wage Indexing

By 1976, the need for substantial revisions in the Social Security program and its financing was overwhelmingly clear.(19) In June, the Ford Administration submitted to Congress a proposal to create a new method for determining initial benefits(20) based on an approach called "wage indexing," a method which adjusts a worker's wages to reflect economy-wide changes in wages over his or her lifetime.'' Hearings were held on this proposal, but Congress adjourned for the upcoming Presidential elections before completing a full review.

The new administration of President Carter sent its proposals to Congress in May 1977. Its package included the same "wage indexing" solution proposed by the Ford Administration as well as many new tax and financing proposals.

Despite the two Administrations' support for wage indexing, Congress examined numerous alternative proposals!! in a lengthy series of hearings. Ultimately, both the House and the Senate adopted legislation replacing the flawed 1972 method with a wage indexing method, and President Carter signed these new Social Security amendments into law on December 20, 1977.

These new amendments preserved the way that benefits were adjusted for inflation for those already on the rollsCin other words, existing beneficiaries continued to receive annual increases (COLAs) based on the percentage increase in the CPI. The way initial benefits were calculated. however, was completely revised.

Under the old law, a person's initial benefit was determined by averaging the actual wages he or she earned (in "covered" jobs) over a period roughly equivalent to a working lifetime. A benefit table was then used to determine the basic amount payable.

But since earnings levels in the economy tend to increase each year, initial benefits tended to creep up as the worker's average earnings rose. In addition, these benefits were also "price-indexed" -adjusted for inflation - since the figures in the table rose by the percentage increase in the CPI.

Fixed Formula Introduces Wage Indexing

Thus the old law generated, under some economic conditions, inflated initial benefits by linking, or "coupling," the effect of both wage and price increases. The 1977 legislation "de-coupled&quot 23) those two elements, substituting a fixed formula for determining initial benefits: (24)

1. 90 percent of the lowest range of average indexed monthly earnings, plus
   
2. 32 percent of the mid range of such earnings, plus
   
3. 15 percent of the highest range of such earnings (up to a maximum based on amount of earnings on which taxes are paid).

Like the old approach, this new approach used average earnings over a "working lifetime." But those earnings would now be adjusted ("indexed&quot to reflect the growth of wages in the economy Cin other words, past wages would be translated into their equivalent in current wage levels.(25)

By adopting this new method, Congress purposely lowered initial benefits to offset the unintended increases that would have occurred as a result of the flawed 1972 method. However, it protected anyone who reached eligibility age prior to 1979Cthat is, anyone born before January 2, 1917 Cby "grandfathering" them under the old law. This protected people already on the benefit rolls as well as those who could have retired in 1978 or earlier but continued working. For those who continued working, the initial benefit calculations resulting from this grandfathering proved especially generous.

Thus a worker retiring under the new law would generally receive lower benefits than a worker I retiring under the old law, which was the intent of Congress. To minimize the abruptness of this change, however, Congress created a special five-year "transitional method" for people who would become eligible for benefits beginning in 1979.(26) In other words, those born between 1917-21 would I be the first to have their benefits calculated under the new law. This "transitional method" was designed to ease their transition to the new, lower level of benefits.

The transitional method was identical to the old method except (1) earnings after age 61 could not be used in figuring benefits, and (2) after 1978, no inflation adjustments would be made until age 62.(27) Individuals eligible for the transitional method would have their benefits computed under the new law method if it produced higher benefits.

The transitional method did not alterCnor was it intended to alterCthe fact that people born after January 1, 1917 would receive, with few exceptions, lower benefits than those born prior to that year. That was the purpose of the 1977 law.

http://www.ssa.gov/history/notchfile1.html