For many of the nearly 64 million Americans receiving a Social Security benefit each month, no annual announcement bears more importance than the cost-of-living adjustment (COLA). As the name implies, Social Security's COLA is the "raise" that the program passes along to its recipients each year that's designed to account for the inflation they've been facing. I say "raise" with quotation marks because it rarely ever outpaces inflation, and therefore isn't a true raise that would help beneficiaries get ahead.
Between 2000 and 2009, Social Security beneficiaries walked away with an average annual COLA of 3%. But over the past decade, the average Social Security COLA has been downright pitiful -- an average of 1.4%. This includes three separate years where no COLA was passed along (2010, 2011, and 2016), as well as the lowest positive COLA in history, a 0.3% "raise" in 2017.
How has Social Security's most important measure failed seniors so badly over the last 10 years? The answer boils down to three factors.
How is Social Security's COLA calculated?
Before I dive into the specific reasons why Social Security's COLA is failing our nation's retirees, it's important to understand how the program calculates its annual cost-of-living adjustment.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been Social Security's inflationary tether. It has eight major spending categories and dozens upon dozens of subcategories, all with their own individual weighting. The purpose of all of these subcategories is to measure changes in the price of goods and services, thereby allowing the U.S. Bureau of Labor Statistics (BLS) to report monthly inflation data.
With regard to Social Security, only the three months during the third quarter (July through September) count toward determining its COLA. The average CPI-W reading from the third quarter of the current year is compared to the average CPI-W reading from the third quarter of the previous year. If the value rises from one year to the next, it signals inflation, and every beneficiary gets a raise that's commensurate with the year-over-year increase, rounded to the nearest tenth of a percent.
Meanwhile, in the rare event that the CPI-W falls from one year to the next, benefits remain static (i.e., no COLA). As noted, this has happened three times over 45 years, albeit all three instances have occurred over the past decade.
Here's why Social Security's COLA has been so low over the past 10 years
Now that you have a better idea of how Social Security arrives at its annual COLA, it'll be easier to explain why it's failing seniors so badly.
As noted by the official name of the CPI-W, it's an index that tracks the spending habits of urban and clerical workers. The problem is that urban and clerical workers spend their money very differently than senior citizens, yet seniors make up more than 4 out of 5 Social Security beneficiaries. This leads to some important spending categories not getting enough weighting in the annual COLA calculation.
Thus, the first reason Social Security's COLA has been minimal over the past 10 years has to do with an underweighting of medical care expenses. Not only do urban and clerical workers spend far less on medical care than seniors, but the CPI-W doesn't do a very good job of accounting for important medical expenses, such as those tied to Medicare. In more years than not, medical care inflation has handily topped Social Security's COLA over the past 10 years.
Secondly, but building on this point, the CPI-W tends to underweight the importance of housing expenditures for senior citizens. When comparing the experimental Consumer Price Index for the Elderly (CPI-E) with the CPI-W back in Dec. 2011, the BLS found that housing accounted for 39.2% of total expenditures with the CPI-W, which was notably lower than the 44.5% of total expenses that housing accounted for with the CPI-E. Translation: Seniors spend more of their money on shelter, but aren't seeing this factored into the annual COLA passed on by Social Security.
The third and final problem is that energy prices have fallen off a cliff over the past decade. Even though energy has historically made up only around 8% of the total weighting of the CPI-W, the price of crude has been weighed down pretty substantially for the past five years, as well as in the few years following the Great Recession. Though lower prices at the pump are great for consumers, it's not good news for Social Security's COLA.
All three of these factors are to blame for Social Security's anemic COLAs over the past decade.
The icing on the cake
What's arguably the icing on the cake here is that neither Democrats nor Republicans favor the CPI-W as the program's inflationary measure. Both parties believe it's doing a poor job of accurately measuring the inflation that program recipients are contending with. And yet, absolutely zero progress has been made on Capitol Hill to replace it.
The reason? Neither party is willing to cede an inch to find common ground with their opposition. Democrats prefer utilizing the CPI-E moving forward, whereas Republicans favor the Chained CPI, which takes into account the idea of substitution bias. Over time, the Democrats' solution would likely expand Social Security's COLAs, whereas the GOP's would further reduce COLA.
With neither party able to work with the other, we've seen the purchasing power of Social Security dollars decline by 18% over the past decade, according to an analysis by The Senior Citizens League. This weakness in purchasing power, while glaring to lawmakers, is unlikely to cease anytime soon.