Chained CPI: Diet COLA for Social Security
Chained CPI: Diet COLA for Social Security
As negotiations between President Obama and Speaker Boehner rapidly close on the end of the year deadline for avoiding the fiscal cliff, media attention has been focused on the back-and-forth over increasing taxes.
But there hasn't been much attention to the spending side of the negotiations. That is, however, with one exception — changing the way Social Security Cost-of-Living Adjustments (COLAs) are computed.
One proposal would move the COLA from the current CPI-W to the so called "chained CPI," which aims to be a better measure of inflation by assessing how consumers change their behavior in response to changes in prices. A recent survey of top economists agreed that "the annual indexing of Social Security benefits to increases in the Consumer Price Index for urban wage earners and clerical workers (the CPI-W) leads to higher benefits than would be required to compensate recipients for genuine cost-of-living increases."
Opponents of moving to a chained CPI would have you believe this change would result in cutting senior citizens' benefits by thousands of dollars — but that's far from the truth. Yet before we discuss the nuances of the different measures of the CPI, it is important to keep in mind that millions of Americans rely on Social Security benefits for income protection. In fact, 65% of all beneficiaries rely on Social Security to provide 50% or more of their incomes, while 36% rely on benefits for 90% or more of their incomes. For non-married beneficiaries, including widows, the reliance is higher with 74% relying on benefits for 50% or more of their incomes and 46% relying for 90% or more of their incomes.
An important component for keeping Social Security beneficiaries out of poverty is the COLA. In order to keep inflation from eroding purchasing power, benefits are purposefully designed to increase with price inflation and without political interference. Legislation enacted in 1972 required that beginning in 1975, future cost-of-living adjustments to Social Security and Supplemental Security Income (SSI) benefits be tied to the Consumer Price Index. This also ensures that COLA increases are not tied to the direction in which the political winds blow.
The Social Security Act specifies that any COLA be based on the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the previous year to the third quarter of the current year. If a COLA is warranted, it shows up in benefit checks beginning the following January. If there is a decrease in the CPI, or deflation, no COLA is provided. Further, no COLA can occur in subsequent years until the CPI exceeds the previous highest level. Though benefits can increase, it is important to note that Social Security benefits never decrease, even during periods of deflation and a decline in the CPI. For more information, see a short report I wrote in 2010 or the information provided by SSA.
Now let's discuss the nuances of moving to a chained CPI. According to the Chief Actuary at the Social Security Administration , the average difference would amount to 0.3 percentage points a year. The congressional Budget Office estimates the difference would be even less, at 0.25 percentage points per year. To be clear, we're talking about 0.3 percentage points , not a 3% difference. For example, if the COLA under the current formula called for a 1.0% increase, a 0.3 percentage point decrease would bring the COLA down to 0.7%. This would still result in an increase in benefits both on a nominal and real-inflation adjusted basis.
As it stands under current law, Social Security beneficiaries are set to get a 1.7% COLA starting in January of 2013. No matter what happens with the fiscal cliff negotiations, this COLA is set in stone. Nobody is going to change the 2013 COLA. But what would the COLA be if we had the chained CPI? Instead of a 1.7% increase, the COLA would be 1.5% instead — a 0.2 percentage point difference.
What does this mean in actual dollars? The average retired worker on Social Security received $1,240 a month in 2012. The scheduled 1.7% COLA for 2013 will increase this average monthly benefit to $1,261, or a $21 increase per month. If the COLA was instead based on the chained CPI , the 1.5 % increase would bring the average monthly benefit up to $1,259, a $19 increase in monthly benefits and only $2 less per month than based on the current CPI.
The Social Security Trust Funds are currently estimated to become insolvent in 2033 . While I understand every dollar counts when you're on a fixed income, a difference of $2 a month ($24 a year) hardly amounts to draconian benefit cuts for seniors. That said, I think it's important to stress that moving to a chained CPI isn't just about saving money or slowing the growth of benefits, it's primarily about getting the measure of inflation correct. The change to a chained CPI should be made even if it didn't produce appreciable savings. It should be done because it's a more accurate measure of inflation. The goal of the COLA is to protect beneficiaries' purchasing power accurately, and moving to a chained CPI accomplishes this goal.
Basing the COLA on the chained CPI is a modest tweak to Social Security benefits that only slows the growth of benefits, does not lead to actual cuts in benefits, and is a first step toward improving the solvency of the Social Security system.Comments