A study released by the Senior Citizens League in June finds that annual inflation increases have resulted in Social Security payments increasing 46% since 2000. That may sound like a healthy pay raise, but the average retiree's expenses nearly doubled over the period. As a result, retirees have seen a 34% decline in their purchasing power since 2000, including a 4% decline in 2017 alone.

Will Congress change how Social Security calculates its annual increases to stop retirees' buying power from falling further?

What's happening

A pay-as-you-go program that's funded by payroll taxes on current workers, Social Security provides valuable income to over 43 million retired Americans every month.

An older woman pointing her thumbs downward.

IMAGE SOURCE: GETTY IMAGES.

The amount you can receive in Social Security is determined by a complex calculation based on your highest 35 years of employment, adjusted for inflation, and on the age at which you begin receiving benefits.

Once you begin collecting Social Security, you qualify for annual cost-of-living adjustments (COLA) designed to protect your buying power against the rising cost of goods and services, or inflation.

The amount that COLA increases your benefit by every year is determined by a formula that determines the average increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) every third quarter, from the average third-quarter CPI-W from the last year that a COLA increase was awarded.

For example, the average CPI-W in Q3, 2017 was 239.67, and that was 2% higher than the CPI-W in Q3 2016, the last year a COLA increase was granted. As a result, Social Security recipients got a 2% boost to their income in 2018.

In theory, COLA increases should insulate retirees from rising prices, but since retirees spend more of their money on goods and services that are seeing above-average inflation, tying COLA to CPI-W has failed to keep up with expenses.

For instance, prescription-drug spending has increased 188%, and overall medical spending has increased 117% since 2000. Seniors' monthly Medicare Part B insurance payment alone has grown by an eye-popping 195%, too. The negative impact on retiree budgets from those increases more than offsets any savings associated with the 11% decline in used vehicle prices and 2% decrease in clothing -- two expenses that aren't nearly as important to retirees as healthcare.

Fixing the problem

If Social Security switched its annual COLA formula to reflect changes in the Consumer Price Index for the Elderly (CPI-E), then increases would more accurately reflect real-world spending in retirement. However, although organizations such as the Senior Citizens League have advocated for such a change, politicians have suggested changing the calculation to chained CPI-U -- the Consumer Price Index For All Urban Consumers, a measure that grows more slowly than CPI-W -- to save money instead.

Congress is right to want to put Social Security's books in order, because Social Security's tax revenue has been lower than its payments to recipients since 2010. The trust fund that's making up the difference between tax revenue and payments is projected to run out of money in 2034, causing an across-the-board 25% cut to benefit payments.

Changes need to be made to avoid such a reduction, but given the loss of purchasing power for seniors already, and the likelihood that healthcare costs will grow, not shrink, in the future, decreasing COLA increases doesn't seem smart. 

The Motley Fool has a disclosure policy.