Why Social Security COLAs Aren’t Keeping Up With Inflation

By on November 9, 2016 in Retirement with 0 Comments

Image of Social Security cards with $100 dollar bill

Three weeks ago, the Social Security Administration (“SSA”) informed seniors that they would receive an additional 0.3% in benefits in 2017 for changes in the cost of living.

And chaos ensued as politicians and pundits fostered a feeling of loss in seniors that materialized as anger. In the net, people feel cheated because they believe that the increase does not match the actual inflation that they experience at the store.

Social Security’s COLA is not a raise. It is a mandated annual adjustment to preserve the buying power of benefits as an offset for inflation. Your checks might increase, but the buy power roughly stays the same.

The adjustment is based on the changes of price levels in a basket of goods called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The index tracks the level of inflation found goods and services for most working class Americans.

This process is not an exact science. It is the government’s best guess because price changes do not affect everyone evenly.

One of the largest weights in the index is housing, a cost that many seniors do not even have. In other words, the adjustment protects your benefits based on what other people spend.

This process is a sensitive subject with beneficiaries who have suffered through a series of zero COLAs over the last six years while their most visible expense, Medicare, has soared in price. Even though seniors will get an increase, many feel that the 0.3% boost is simply too small.

It is small, and there two reasons why it is small.

First, the formula used a value from 2014 instead of 2015 as a baseline. Separately the falling price of gasoline tended to weight-down the overall price index in 2016.

First, there was no COLA adjustment for 2016. As result, the formula for 2017 used the CPI-W from 2014 rather than 2015 as the baseline. 2017 is a catch-up year, where seniors will get 0.3 percent rather than 1.5 percent. It is possible to say that seniors should be glad that benefits were not reduced for 2016 to reflect the decline in overall pricing.

Second, the rise in the cost of Medical Care was offset by the falling cost of gasoline. While Medicare is not specifically tracked, the index shows that health insurance rose 9.1 percent over the past year. That cost is blended into Medical Costs which accounts for about 7 percent of the index. In contrast, gasoline feeds into transportation which has more than double the weighting.

Chart showing the relative importance of categories in consumer price index

Image source: U.S. Bureau of Labor Statistics

This contrast drives the anger. Seniors complain that the adjustment for the coming year is too low because the spending habits of retired workers differs from the majority of America. Critics of the system on the other hand believe that CPI-W actually overstates the rate of inflation.

There is no right answer. In 2007 CPI-W rose by more than 4 percent in part because of rising energy costs. No one complained about the weighting then. This year, the rental of homes, a cost that many seniors do not even have, contributed 3.6 percent to the index. The COLA is just a best guess.

I see the point that seniors are making. CPI-W gives the entirety of Medical Care a weight of around 7 percent. By comparison, the expense of my health insurance alone is 30 percent of my household expense. Insurance doesn’t pay for any healthcare. It is the cost of the access to healthcare.

At the same time, it is not reasonable to expect the cost of living adjust to match a cherry-picked statistic like health insurance.

© 2016 Brenton Smith. All rights reserved. This article may not be reproduced without express written consent from Brenton Smith.

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About the Author

Brenton Smith (A.K.A. Joe The Economist) is the founder of “Fix Social Security Now” which provides information on all alternatives in the public debate on Social Security through its site www.FixSSNow.Org.

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