Each month, America's most important social program, Social Security, pays out more than 63 million benefit checks. While not all retired Americans will receive a benefit check, those who do tend to be very reliant on what they receive from the program. According to the Social Security Administration (SSA), 62% of retired workers receive at least half of their income from the program, with about a third essentially leaning on Social Security for virtually all of their income.
Because of its importance, there's perhaps no announcement that's more anticipated by our nation's retired workforce than the October-released cost-of-living adjustment, or COLA. Think of COLA as the "raise" that all beneficiaries receive as a result of inflation (i.e., the rising cost of goods and services). Unfortunately, this much-anticipated announcement is almost always a no-win situation for seniors.
But before I explain why that's the case, let me briefly walk you through how the SSA calculates COLA each year.
Understanding how COLA is calculated
The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the program's inflationary tether since 1975. Prior to this, benefit increases were arbitrarily passed along by a special session of Congress. The CPI-W has eight major spending categories and dozens upon dozens of subcategories that measure the price movements of consumer goods and services.
For the purposes of Social Security, only the CPI-W measurements in the third quarter -- July through September -- have bearing on COLA. None of the other nine months factors into the calculation. To calculate COLA, the average CPI-W reading from the third quarter of the previous year is compared to the average CPI-W reading from the third quarter of the current year. If the current year reading is higher, then beneficiaries are going to get a raise that's commensurate with the year-over-year percentage increase and rounded to the nearest 0.1%. In the rare event that prices fall from the previous year, benefits remain static the following year. They can't drop because of deflation.
This probably all sounds pretty straightforward, and it is. But there are multiple pitfalls along the way that prevent seniors from keeping up with inflation.
Social Security's COLA is a no-win situation for seniors
To begin with, the CPI-W is inherently flawed as a measure for the Social Security program. There's no issue with the methodology of the index itself, but tying Social Security's COLA to an inflationary measure that tracks the spending habits of urban and clerical workers makes no sense. Working-age urban and clerical workers are very unlikely to be receiving Social Security benefits -- about 70% of all Social Security recipients are retired workers -- and their spending habits differ pretty significantly from retired workers. Ultimately, this leads to important expenditures for seniors, like housing and medical care, receiving far less representation than they should, while lesser-important costs, such as education, apparel, entertainment, and transportation, are overemphasized.
But there are other aspects to consider here. If, for example, seniors do receive a healthy COLA, as they did this year when the largest COLA in seven years was passed along (2.8%), it's not as much of a positive as it seems. Higher COLAs mean that inflation is rearing its head somewhere throughout the economy. Thus, while seniors are potentially receiving more each month, they're also likely spending more to compensate for the rising price of goods and services. To be clear, COLA isn't designed to help seniors "get ahead." However, a higher COLA still doesn't guarantee that retired workers are even keeping up with inflation.
COLA will also depend on what factors contributed to inflation. Building on the first point -- that the CPI-W is inherently flawed as a cost-measuring index for Social Security -- weakness in energy prices (more specifically crude oil) pushed COLA into the negative in 2010, 2011, and 2016. This represents the only three times it's been negative since annual COLAs began more than four decades ago. Unfortunately, all three of these years saw relatively high levels of medical care inflation. Therefore, even though deflation was present as a whole, the more important costs to seniors, such as medical care, rose significantly, thereby reducing the purchasing power of Social Security dollars as benefits remained stagnant from one year to the next.
According to The Senior Citizens League, the purchasing power of Social Security dollars has fallen 34% since the year 2000.
There's no easy fix, either
Then, there's the icing on the cake. Namely, that fixing these deficiencies is almost impossible. That's because Democrats and Republicans each have a solution, and they're at opposite ends of the spectrum. Not to mention, both solutions come with drawbacks.
The Democrats' fix involves replacing the CPI-W with the Consumer Price Index for the Elderly (CPI-E). As the name implies, the CPI-E would take into account the spending habits of senior households, thereby getting a more accurate reading of housing and medical expenditures, and leading to a larger annual COLA. It sounds great on paper, but what most folks don't realize, courtesy of the Government Accountability Office, is that the CPI-E is considered an experimental measure by the Bureau of Labor Statistics. In order to refine its methodology, it would cost quite a bit and take a lot of time.
Meanwhile, the Republicans prefer turning to the Chained CPI, which takes into account the idea of substitution bias. If, for example, the price of ground beef rises a lot and consumers choose to buy pork or chicken instead, this is an example of substitution bias in action. While representing a real consumer action, the Chained CPI would almost certainly recognize lower annual COLAs over time than even the CPI-W, further worsening the loss of purchasing power for seniors.
Even if there is a clear fix, 60 votes would be needed in the Senate to amend the Social Security program, and it's been 40 years since either party held a supermajority of 60 votes in the Senate. Therefore, any changes would require bipartisan cooperation, which hasn't happened on Social Security in a very long time.
The sad truth is, Social Security's COLA is built to fail the seniors who need it most.