For better or worse, Social Security is the most vital program for seniors in this country. According to statistics from the Social Security Administration (SSA), some 62% of aged beneficiaries lean on their monthly check to account for at least half their income, with another 34% counting on Social Security to essentially provide all or nearly all of their monthly income. It's simply that important.

But the Social Security program is itself not as cut and dried as you might think. In addition to providing retirement benefits to the elderly, it's also responsible for providing income to the long-term disabled and the survivors of deceased workers. Spouses and children of eligible beneficiaries in all three categories may qualify for benefits, too. Trying to keep this gamut of beneficiaries satisfied isn't easy, to say the least.

One of the biggest issues that arises with having 62.1 million monthly beneficiaries of varying age groups is how to account for inflation -- the rising cost of goods and services. 

An elderly man counting cash in his hands.

Image source: Getty Images.

Social Security's inflation problem, in a nutshell

Right now, Social Security's inflationary tether is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Every October, the SSA takes the average reading of the CPI-W during the third quarter of the previous year (July through September) as its baseline figure, and then compares it to the average reading of the CPI-W during the third quarter of the current year, as released by the Bureau of Labor Statistics. If the reading -- a measure of eight major spending categories --- rises year over year, Social Security beneficiaries receive a "raise" in their payout (officially known as a cost-of-living adjustment) beginning the following year that's commensurate with the percentage increase in the year-over-year CPI-W reading, rounded to the nearest 0.1%. If the CPI-W falls from the previous year, benefits remain static. Thankfully, deflation can't cause a reduction in Social Security benefits from one year to the next.

This probably sounds pretty straightforward and fair -- but it's not.

You see, the CPI-W measures the spending habits of working-age Americans in the urban and clerical setting. However, the February 2018 snapshot from the SSA shows that 68.8% of all beneficiaries are age 62 and up. Thus, a program where almost 69% of all beneficiaries are aged 62 and up (an age group that receives 75% of the $80.2 billion in monthly benefits) is being determined by the spending habits of working-age Americans who make up a very small percentage of current beneficiaries. That doesn't make a lot of sense.

What's more, it tends to hurt seniors directly in their pocketbooks. The elderly tend to dedicate twice as much of their aggregate spending to medical care, as well as more on housing costs, relative to working-age Americans. With less emphasis on these key expenditures, the annual cost-of-living adjustment tends to underreport the true inflation that seniors are facing. The result? Seniors' Social Security purchasing power is declining with each passing year.

A senior woman buying groceries.

Image source: Getty Images.

Democrats have a solution, but it has flaws

The reality is that the CPI-W isn't working very well for the biggest group of recipients of Social Security benefits: seniors. However, switching to alternative measures of inflation comes with its own set of positives and problems.

The Democrats have a pretty simple, and seemingly logical, approach: Switch to the Consumer Price Index for the Elderly, or CPI-E. As the name suggests, it would take into account the spending habits of households with persons over the age of 62. Such a measure would more adequately factor in the medical and housing expenditures that seniors today are facing, and in turn result in higher annual cost-of-living adjustments.

While that probably sounds great to most seniors, there are two major drawbacks to this approach. First, Social Security is currently facing a $12.5 trillion cash shortfall between now and 2091, and adjusting its inflationary tether to pay out even more to seniors would only exacerbate this cash shortfall. Unless lawmakers can find new ways to generate revenue, the CPI-E is only going to shorten the time it takes for Social Security's asset reserves to be depleted.

The other issue is that even the CPI-E would likely underreport the inflation most seniors face. The CPI-E doesn't factor in Medicare Part A expenses (hospital insurance), which can be substantial for some seniors. Without taking this into account, it's probable that Social Security benefits would continue to lose purchasing power, even with the CPI-E, albeit to a lesser degree than under the CPI-W.

A Social Security card sticking up out of a small pile of cash.

Image source: Getty Images.

Republicans would push the needle in the other direction

The GOP also wants to change Social Security's inflationary tether, but not to the CPI-E. Instead, GOP lawmakers prefer using the Chained CPI.

The Chained CPI and CPI-W are actually very much alike. They factor in similar spending categories and would use year-over-year readings to determine cost-of-living adjustments. The difference is that the Chained CPI takes into account substitution bias. In other words, if an item or service becomes too pricey, it assumes that consumers will trade down to a cheaper item or service. For example, if beef prices rise, consumers will buy pork or chicken instead. Republicans suggest that this method of measuring inflation would be the most realistic for everyone, since it describes a genuine consumer purchasing habit.

However, switching to the Chained CPI would wind up reducing cost-of-living adjustments across the board for all beneficiaries. Taking into account the ability of consumers to trade down would reduce the inflation experienced by beneficiaries, reducing annual "raises." Implementing the Chained CPI would reduce Social Security's long-term expenditures and likely lower the purchasing power of Social Security dollars even quicker than the CPI-W.

This is the inflation problem the lawmakers have to solve: How best to keep all beneficiaries happy, while at the same time trying to recognize the actual inflation those beneficiaries are facing. There's no easy solution, meaning declines in purchasing power are expected to continue moving forward.

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