Many aspects of the Social Security program are in need of reform, but the way cost-of-living adjustments (COLAs) are calculated is one of the most pressing issues. COLAs are supposed to preserve the buying power of Social Security by ensuring that benefits increase in lockstep with inflation. But many experts argue that the math is flawed.
According to The Senior Citizens League, COLAs have boosted Social Security benefits by 64% since 2000, but the expenses of a typical senior have climbed 130% during that time. As a result, Social Security benefits have lost 40% of their buying power, suggesting that COLAs have utterly failed to keep pace with rising prices.
Many experts are calling for a change that would mean thousands of extra dollars for retirees.
How cost-of-living adjustments (COLAs) are calculated
Since 1972, the Social Security Administration (SSA) has measured inflation and calculated COLAs using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Specifically, the CPI-W from the third quarter of each year is compared to the CPI-W from the third quarter of the last year. The percentage increase (if any) becomes the COLA for the next year.
That seems fine at first glance, but there is a problem. CPI-W is based on purchases made by office workers and hourly wage earners, and the spending patterns of working-age individuals typically differ from those of retirees. For instance, the working population tends to spend more on education, apparel, and transportation, while the retired population generally spends more on housing and medical care.
To that end, many experts and politicians believe the Consumer Price Index for the Elderly (CPI-E) is a better option. It's based on purchases made by individuals 62 years of age and older, meaning it naturally emphasizes the spending categories that are most relevant to retirees.
How big is the impact? If the CPI-E had been used to calculate COLAs over the last two decades, the average retired worker would have received an extra $5,800 in retirement benefits during that time.
Limitations of the CPI-E
The CPI-E is a focal point of several pieces of legislation that currently sit before Congress, including the recently introduced Social Security Expansion Act and the CPI-E Act of 2017. Bipartisan support is often needed to pass legislation in Washington, and that is sometimes easier said than done. But the U.S. Bureau of Labor Statistics also mentions limitations to the CPI-E.
Most notably, the same survey is used to calculate most variations of the Consumer Price Index (CPI), but the survey itself was designed to measure the Consumer Price Index for All Urban Consumers (CPI-U). That means most of the survey data is irrelevant to the CPI-E population, so the CPI-E calculation is performed using a small subset (roughly one-fifth) of the full sample. That makes the CPI-E prone to error, simply because it is based on limited data.
Nonetheless, common sense suggests that COLAs should be based on the spending patterns of retirees, not working-age individuals. That means something needs to be revised. Unfortunately, the wheels of change often turn slowly, and the government has yet to take any definitive action. Fortunately, retirees are on pace to see the largest COLA in the last four decades in 2023, which might bring a little relief.
