COLA Wars

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By on March 2, 2017 in Retirement with 0 Comments

Stack of coins along with letters 'CPI'

Yesterday, Congressman John Garamendi (D-CA) introduced the “CPI-E Act of 2017”, which would change the Cost of Living Adjustment (COLA) formula to use CPI-E rather than CPI-W to make the calculation more accurate.

The measure of inflation (“CPI”) tracks the change in prices of a basket of goods. Each item in the basket has a weight in proportion to its importance in a consumer’s buying habits. Housing for example has a higher weight than travel. The Congressman wants to change the mix of the basket to one consistent with the lifestyles of seniors.

Over the past 30 years, the new index has risen about .2 percent more quickly than the existing measure. The general idea is that the new measure will always run higher, and hence lead to more benefits.

Hurray for more benefits!

Life isn’t that simple. The proposed changes extend beyond retirement benefits from Social Security. It would create a new COLA for those on disability, survivor’s benefits, federal retirement plans, veterans, as well as VA compensation for dependents. Many of these people are not elderly.

These people represent the core problem with all legislation that deals with COLA adjustments. It doesn’t matter when the change is plus or minus, everyone claims to have the more accurate measure of inflation. Here we are applying an index created for the elderly to people who aren’t even retired in some cases.

The fact is that no right version of the COLA exists because inflation affects individuals differently.

For example, the person who owns his home does not feel the effects of changes in price of rent. Thus the COLA will be right for 1 and wrong for 99 with almost any measure of inflation. Arguing about the right measure of inflation is no more sensible that arguing about who is the greatest right fielder ever to play baseball. (Roberto Clemente is the correct answer)

The problem is that the discussion of the COLA is more passionate than baseball. In the case of Social Security, the uncertainty over the annual adjustment has fostered resentment in seniors that the low-COLAs over the past few years have treated them unfairly. This feeling is really not new. It dates back almost to the creation of the COLA process.

My advice to the aggrieved: be careful what you wish for.

COLAs are not raises. The COLA serves to protect the buying power of a senior’s benefit, which becomes fixed once the worker stops contributing to the system. Without this mechanism, the buying power of benefits would fall progressively as the retiree becomes less able to work. That is a crazy mechanism for old-age insurance.

The COLA is a vital aspect of Social Security, particularly in a world where many personal pensions are generally not protected against inflation. Given the SSA’s assumptions, the senior who reaches 95 years old collects a check from his private pension that buys less than half of what he received when he was 66. Basically, as the dependency on a pension rises, the level of the benefit falls.

Given a ubiquitous uncertainty over what is the right COLA, it is not difficult to engender rage about any adjustment. An article can create the desired moral outrage merely by suggesting that a study says that one simple fix could increase lifetime benefits by $30,000 as though the money is ever present and being withheld by the skinflints in Congress.

If you read the study, it says that the fix is “simply” to spend more money by changing the COLA from CPI-W to CPI-E. Understand that any such increase in benefits is offset dollar for dollar with future benefit reductions. While one senior may benefit at another’s expense, seniors collectively break-even. Seniors will not collect a penny more, much less $30,000.

Shifting the inflation measure from CPI-W to CPI-E does not fix Social Security because neither index tracks the driver of inflation, which is healthcare. Medical care accounts for 7 percent of the current CPI figure, and of that amount health insurance accounts for less than 14 percent of the segment.

In my case, the cost to buy healthcare has exploded. If I tried to maintain my access to healthcare, the cost of insurance by itself would exceed the cost of housing which has a weight of more than 40%. This year, the deductible for every member of my family is more than 3 times what I used to buy. The doctor network means that I need to drive 20 miles to see a doctor. Along with these concessions to the rising cost of healthcare, I still pay 15 percent more this year than last.

So you are likely going to ask, why don’t we give the rising cost of healthcare more influence in the CPI-W?

There are two reasons. First, increasing the weight of healthcare satisfies beneficiaries when healthcare costs are the driver of inflation. Once the pricing pressure of healthcare is under control, seniors will complain again about how the index is conceived. Back in 2007, gasoline was the concern. As prices have fallen, activists argue that seniors do not drive as much. This cycle is never ending.

The larger concern is that Social Security would implode if inflation exceeds wage growth over time. Social Security’s revenue is based on wages. The expense of the program is highly connected to inflation. If the rate of inflation exceeds the rate of wage growth, boom.

The problem for seniors isn’t the COLA. The problem is the pace at which healthcare costs are rising. Increasing the levels of benefits only treats the symptoms and ignores the disease. Randomly driving the level of benefits higher doesn’t help seniors. It is a way to placate a segment of the active voter base in the face of a real problem and sets the stage for a crisis in Social Security, which would be a national debacle.

The nation should have a serious discussion about how the cost of insurance has spiraled higher, and yet insurance companies are claiming that they are going broke. Social Security’s COLAs have almost nothing to do with that discussion. Yet, instead of having that discussion, it is more politically expedient to incorporate changes to Social Security so that voters are less inconvenienced by the problem.

© 2017 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) 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.

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