Every October, tens of millions of Social Security beneficiaries wait on the edge of their seats for the most important announcement of the year. You see, the second week of October is when the U.S. Bureau of Labor Statistics (BLS) releases September's inflation data, providing the last piece of the puzzle needed to calculate Social Security's cost-of-living adjustment (COLA) for the upcoming year.
Social Security's COLA is, in nominal terms, a "raise." It provides a monetary boost for Social Security recipients that's meant to account for the inflation they've contended with over the previous year. And it's so highly anticipated because 62% of retired workers currently receiving Social Security count on the program to account for at least half of their income.
How has the most recent Social Security COLA affected payouts? Let's take a closer look by first examining the magnitude of the COLA increase for 2020 and why this year's increase is less than 2019's, and then discuss how this affects beneficiaries' pocketbooks.
Social Security's 2020 COLA was adversely affected by energy prices
In October, following the BLS inflation data release, the Social Security Administration (SSA) announced that COLA would equal 1.6% in the coming year (i.e., 2020). You'll note this is down from the 2.8% increase that the program's tens of millions of beneficiaries received in 2019, which was the largest nominal increase since 2012. However, relative to other COLAs passed along over the past decade, the 1.6% increase was slightly above the decade average of 1.4%.
Why the decline in COLA this year from last year? The answer can mostly be traced back to the energy sector.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been Social Security's inflationary tether. The CPI-W is responsible for tracking consumer spending habits on a predetermined basket of goods and services, with Social Security's COLA wholly determined by the change in the average CPI-W reading in the third quarter of the previous year to the average CPI-W reading in Q3 of the current year.
In 2018, West Texas Intermediate crude wound up rising in the neighborhood of 10% during the third quarter. Hurricanes played a big role in impacting offshore production in the Gulf of Mexico and refining capacity, ultimately leading to higher prices at the pump. That's why 2019's COLA was such a robust 2.8%. Last year, we saw WTI crude actually fall in the third quarter, with hurricanes not playing as much of a spoiler on production and refining capacity. Thus, "only" a 1.6% COLA in 2020.
Here's how the latest COLA has affected beneficiary payouts
Now that you've got a better idea of why Social Security's COLA rose by a modest 1.6% for the current year, let's take a closer look at what effect that's having on the program's approximately 64 million beneficiaries.
As you might imagine, retired workers account for the bulk of recipients -- about 45 million. Before the application of the latest COLA, the SSA Fact Sheet estimated an average monthly payout in December 2019 of $1,479. Doing a little rounding, this means a 1.6% increase should lead to a $1,503 monthly payout for the average retired worker in January 2020. For the year, retired workers should net in the neighborhood of $284 extra from Social Security.
Of course, Social Security provides benefits to more than just elderly Americans. As of Nov. 2018, about 8.4 million long-term disabled workers were receiving a payout from Social Security. With these disabled workers receiving an estimated $1,238 per month prior to the 2020 COLA, the average disabled worker can expect a $20/month bump in benefits to $1,258 this year.
Another 5.9 million people are survivors are deceased workers, with an average Nov. payout of $1,199 per month. If the 1.6% COLA is applied here, the typical survivor benefit should rise about $19/month to $1,218 in 2020.
Social Security's COLA continues to lose its luster
Although Social Security's COLA announcement in October remains the most-awaited event for beneficiaries, there's no doubt that it's lost the luster it once had. That's because, according to an analysis from The Senior Citizens League, a Washington, D.C., nonprofit organization that aims to support senior issues, the purchasing power of Social Security dollars has declined by 18% over the past decade, and 33% since 2000.
The fact is that the CPI-W simply isn't doing a very good job of accounting for the inflation that senior citizens are contending with. As the official name of the CPI-W entails, it's an inflation index that's measuring the spending habits of urban and clerical workers. The problem is, urban and clerical workers are mostly of working age and rarely are collecting a Social Security benefit. That means that even though seniors make up more than 80% of all Social Security recipients, their spending habits aren't being properly accounted for by the CPI-W.
Interestingly, both Democrats and Republicans agree that the CPI-W isn't doing its job. This might be one of the only true agreements on Capitol Hill regarding Social Security between both parties. The issue is that both parties have proposed unique solutions from opposite ends of the spectrum, and neither party will cede an inch to find common ground.
For example, Democrats want to see the Consumer Price Index for the Elderly (CPI-E) implemented as the program's new inflationary measure. As the name implies, the CPI-E would measure the spending habits of households with persons aged 62 and over. The expectation of implementing the CPI-E is that the average annual COLA would rise over time.
Meanwhile, Republicans prefer switching to the Chained CPI, which is an inflationary measure that takes substitution bias into account. Substitution bias describes the act of a consumer trading down from a pricey good or service to a similar, cheaper good or service (e.g., buying chicken or pork instead of beef). If the Chained CPI were implemented, it would likely hurt the purchasing power of Social Security dollars even more than the CPI-W over time.
With little consensus to be reached on Capitol Hill, expect the faulty CPI-W to remain in place for the foreseeable future.