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The Impact of a Higher Minimum Wage on COLAs for Federal Retirees

The author says that an increase in the federal minimum wage could have an impact on Social Security and the annual COLA for federal retirees.

Last month, Democrats introduced legislation to change the minimum wage from $7.25 to $15. There is no shortage of commentary on the change, but very little of that analysis is dedicated to Social Security.

As you likely have guessed, I believe that Social Security should be part of the discussion. The impact on the program will be visible. As the minimum wage changes, the average wage index will change, and that measure determines what retirees collect and the amount of earnings on which people have to pay taxes. 

While I do not take sides on the wisdom of the proposal, I mention it because I do not think that Social Security gets the attention it deserves. Understand, the program doesn’t operate in a vacuum. There is no protective bubble, insulating the system from the economy as a whole. What happens in to the broader economy bleeds into system from the outside.

In 2019, Congress repealed the Cadillac Tax from the Affordable Care Act, and like magic the program was another trillion dollars in the hole. As the 2020 Trustees Report notes:

On December 20, 2019, the ACA’s excise tax provision was repealed. The repeal of the excise tax is expected to result in an increase in the rate of growth in the average cost of employer-sponsored group health insurance. … This change in law is estimated to decrease the long-range actuarial balance by 0.13 percent of taxable payroll.

This happens when Washington wants to serve one audience without wondering about the rest of us. As happens too frequently, Congress acts to clean-up one mess and creates another. Increasing the paychecks of low-income workers may prove to be very sensible for the individual. At the same time, this type of legislation will affect Social Security in a very unpredictable way. 

Based on a Google search, Social Security is broadly round-off in the discussion about increasing the minimum wage. If you hear about Social Security at all, you hear that increasing the minimum wage would help the program because as the minimum wage increases FICA tax revenue would rise. In an ideal world, employees would get paid more now – and more in retirement. 

Here is the problem with that thinking. Changing the minimum wage would alter the average wage index. That folks – in terms of Social Security – is the drive shaft of the car. The “average wage index” isn’t the bumper. It isn’t a side mirror. It isn’t a spare tire. It is a foundation on which the system works, determining how much a retiree gets paid and how much taxes the program collects.

Gauging the impact of the minimum wage change on Social Security isn’t an exact science. Off the top of my head, there are trends that we should at least think about before the consequences arrive.

  • To the extent that wages rise without anyone getting fired, the average wage index rises, and just like magic, the program owes higher benefits to every newly eligible retiree. 
  • To the extent that employers are able to pass along the higher costs to the consumers, the annual cost of living adjustment (COLA) will generate higher benefit payments for everyone.
  • To the extent that employers trade full-time low-skilled workers for part-time higher-skilled workers the average wage index might fall. 
  • To the extent that teenagers are removed from the labor market, Social Security will lose FICA taxes that are practically free of charge.
  • To the extent that older workers stay in the market, this change represents an increase in the revenue from the taxation of benefits.
  • To the extent that lower-wage earners pay more in payroll taxes, the system’s cost of funds will get worse. These folks are apt to collect benefits within the 32% break-point.

According to the IRS, about 70 million workers earn wages of $30,000 or less. That is more than 1/3rd of the wage base. That is a lot of people. The average wage index and the COLA are both levers of cost. It seems possible that costs could go up by more than revenues.

What this ultimately means for federal retirees is that the annual COLA would be impacted if the federal minimum wage were to be increased. It could result in higher overall COLAs going forward for federal retirees under the right circumstances.

The issue of increasing the minimum wage is visible, and Social Security is visibly absent. Critics of the change do not ask about whether Social Security might be hurt. Supporters do not tell whether Social Security might be helped. It is off the radar.

The point here is we should examine the possibilities before the Trustees of the program have to assess the damage.

About the Author

Brenton Smith (A.K.A. Joe The Economist) writes nationally on the issue of Social Security reform with work appearing in Forbes, FedSmith.com, MarketWatch, TheHill.com, and regional media like The Denver Post.