Social Security is, for a majority of the more than 42 million retired workers who receive a monthly payout, a critical financial lifeline during retirement. Though the average monthly payout only works out to about $1,372 a month as of September 2017, this is still more than half of all monthly income for 62% of retired workers. 

Considering the reliance of retirees on Social Security -- as future retirees are expected to show, too, given their generally poor saving habits -- you'd think lawmakers would be working to secure the future of this program in any way possible. Unfortunately, we've seen just the opposite, with the last major overhaul of Social Security coming 34 years ago during the Reagan administration.

A worried elderly man looking out a window.

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The issue at hand, as described in the latest Social Security Board of Trustees report, is that the ongoing retirement of boomers, combined with lengthening life expectancies, is expected to completely exhaust the Trust's $3 trillion in asset reserves by 2034. Should no congressional actions be taken to generate more revenue and/or cut benefits, the program will be facing an estimated $12.5 trillion budget shortfall between 2034 and 2091. In effect, a 23% across-the-board cut to benefits may be needed to preserve payouts through the year 2091. 

A big dilemma: Social Security's purchasing power is declining

But even with this looming issue just 17 years away, seniors have more immediate concerns. Namely, they want as much out of the program as they can get. This is especially true considering that medical care inflation has topped Social Security's cost-of-living adjustment (COLA) in 33 of the past 35 years. Social Security's COLA is nothing more than the annual raise that beneficiaries receive most years.

According to an analysis by The Senior Citizens League, Social Security's purchasing power has dropped by 30% since 2000. What $100 in Social Security income once purchased, will now only buy about $70 worth of goods and services. That's bad news for those 62% who rely on Social Security as their primary source of income.

A worried couple mulling over their finances.

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Democrats and Republicans want to shift away from the CPI-W

The heart of the problem appears to lie with the tether that the Social Security Administration uses to measure annual inflation: the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. The average reading from the third quarter of the previous year acts as the baseline number, while the average reading from the third quarter of the current year is the comparison. If the prices for the basket of goods and services that the CPI-W measure rises year over year, then beneficiaries get a corresponding raise, rounded to the nearest 0.1%. If it falls year over year, benefits remain the same. They can't fall because of deflation.

Sounds efficient, right?

The problem is that the CPI-W factors in the spending habits of working-age Americans, whereas 68% of Social Security's beneficiaries are retired workers. The result is an added emphasis on things like education, entertainment, transportation, and food and beverage spending, which don't impact the elderly nearly as much, and less emphasis on critical categories for seniors, such as housing and medical care. This is why seniors seem to get the short end of the stick every year when it's COLA time.

Now here's something interesting: Neither Democrats nor Republicans like the CPI-W. Both parties have recognized that it doesn't do an accurate job of properly measuring inflation for seniors receiving Social Security benefits. Unfortunately, neither party can agree on an acceptable replacement. In fact, the suggestions of what should replace the CPI-W are at complete opposite ends of the spectrum.

A retired woman holding a neat stack of cash bills in her outstretched hands.

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Democrats want to switch to the CPI-E

Democrats have long touted the Consumer Price Index for the Elderly, or CPI-E, as the most logical replacement. The CPI-E would only take into account the expenditures of households with persons aged 62 and up, thus more accurately reflecting the spending habits of Social Security's primary beneficiaries (seniors). This means a larger emphasis on housing and medical care expenditures, which should lead to higher annual COLAs.

While the move seems logical on paper, it comes with two primary drawbacks. The first is the aforementioned budget shortfall for Social Security. Switching to the CPI-E would only exacerbate how long it would take before the Trust's asset reserves are depleted. Yes, it'd temporarily give a larger annual COLA to beneficiaries, but would also likely be short-lived.

The other issue is that the CPI-E still fails to take into account certain expenditures, such as Medicare Part A (hospital insurance) out-of-pocket costs. Part A expenses can actually be the largest medical care cost seniors face, yet it's not included in the CPI-E calculation. This would suggest that even switching to the CPI-E could lead to an underestimation of the true inflation seniors are facing.

An elderly woman buying groceries.

Image source: Getty Images.

Republicans prefer the Chained CPI

On the other hand, the GOP has long preferred an inflationary measure known as the Chained Consumer Price Index, or Chained CPI. The Chained CPI and the CPI-W are actually a lot alike, with one exception. The Chained CPI takes into account the idea of substitution. In other words, if the price of a good or service becomes more expensive, the Chained CPI takes into account the likelihood of consumers swapping out that good or service for something cheaper. The CPI-W does not take substitution into account.

So, what's this mean for Social Security's COLA? Adjusting for substitution would mean that annual COLAs would actually be lower than they are under the CPI-W. While Republicans argue that the Chained CPI is a more realistic measure of inflation, it'd ultimately result in smaller annual raises for beneficiaries. That's obviously a problem with Social Security's purchasing power already declining.

However, it can't be overlooked that the Chained CPI might modestly buoy the program's asset reserves if annual COLAs are smaller than they would otherwise be under the CPI-W.

It remains to be seen if either stands any chance of being put into action, but it's pretty clear that neither is a perfect solution.

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