The Mis-Measurement of Permanent Earnings: New evidence from Social Security Earnings Data
This study investigates the reliability of using short-term averages of earnings as a proxy for
permanent earnings in empirical research. An earnings dynamics model is estimated on a large
sample of men covering the period from 1983 to 1997 following the cohort-based methodology of
Baker and Solon (1999). The analysis uses a unique dataset that matches men in the 1984, 1990
and 1996 Surveys of Income and Program Participation (SIPP) to the Social Security
Administartion’s Summary Earnings Records (SER). The results confirm that using a short-term
average of earnings can lead to spurious estimates of the effect of lifetime earnings on a particular
outcome. In addition, the transitory variance appears to vary considerably over the lifecycle. The
share of earnings variance due to transitory factors is higher among blacks and the persistence of
transitory shocks appears to be greater for this group as well. Finally, the transitory variance
appears to be a more important factor in explaining the overall earnings variance of college
educated men than those without college.