There have been 14 recessions in the United States since 1935. This means our nation's most important social program, Social Security, has survived some of the darkest days in U.S. history. And despite the rampant uncertainty associated with the coronavirus disease 2019 (COVID-19) pandemic, it'll survive this recession, too.
Today, Social Security is responsible for paying benefits to nearly 64.7 million people, many of which are retired workers (45.7 million). Of these seniors, more than 15 million are singlehandedly pulled out of poverty each year because of their guaranteed payout from the Social Security program.
Given this reliance on Social Security income, it should come as no surprise that the single-most important event every year for these 64.7 million beneficiaries is the October release of the upcoming year's cost-of-living adjustment (COLA).
Think of COLA as the "raise" that Social Security beneficiaries receive from one year to the next that accounts for the rising price of goods and services (i.e., inflation). I say "raise" in quotation marks, because it's not a raise in the true sense of the word, so much as a boost in payout designed to keep recipients on-par with inflation.
Here's why it's the most important time of the year for Social Security recipients
But in order to get to the single-most important press release of the year, we must first wind our way through the most important time of the year for Social Security beneficiaries -- and that happens to be right now.
You see, Social Security's COLA is calculated using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Since 1975, fluctuations in a predetermined and pre-weighted basket of goods and services allows the CPI-W to show, with a single reading, whether collective prices are rising or falling.
However, not all monthly CPI-W readings are created equally. In determining Social Security's COLA, only readings from the third quarter (July through September) are taken into consideration. Although the U.S. Bureau of Labor Statistics will always report a monthly CPI-W reading, only readings from the third-quarter will aid in determining Social Security's COLA.
To calculate the "raise" that beneficiaries can expect, simply compare the average CPI-W reading from the third-quarter of the current year to the average CPI-W reading from the third quarter of the previous year. If the value has increased from one year to the next, beneficiaries will be netting a positive COLA in the upcoming year. The percentage difference of this increase, rounded to the nearest tenth of a percent, determines how big that raise is.
Thus, with it now being July, we've moved into the months that actually count when it comes to determining next year's COLA.
Prepare for disappointment
Unfortunately for the nearly 65 million beneficiaries, Social Security could do something exceptionally rare this year that pretty much no one wants to see happen.
In the 45 years that the CPI-W has been the program's inflationary tether, there have only been three instances of deflation (falling prices) -- and deflation means Social Security benefits remain static from one year to the next. Based on recent inflation data, we could be looking at the fourth such occurrence.
According to the June inflation data summary from the BLS, the CPI-W has declined by 0.1% over the trailing 12-month period. While certain categories have continued to demonstrate healthy levels of inflation, such as food and medical care services, there's been significant price erosion for energy, apparel, and transportation services. Considering how slowly the U.S. economy is ramping up from its nonessential business shutdown, and taking into account a resurgence of coronavirus cases in a number of states, it looks increasingly likely that there will be no COLA, or perhaps the smallest positive COLA on record, in 2021.
On paper, this might not sound like terrible news. After all, if aggregate prices are falling, then static benefits shouldn't be a bad thing. But it's actually not this simple. While the price for the predetermined basket of goods and services measured by the CPI-W may be falling, important expenditures for seniors, such as medical care services, have actually seen inflation levels accelerate during the COVID-19 pandemic.
One of the more overlooked problems with Social Security's inflationary tether is that it does a terrible job of accounting for the inflation that a majority of the program's beneficiaries face. That's because it's focused on the spending habits of urban and clerical workers, who are rarely seniors and/or receiving Social Security benefits. The result is that important expenditures, such as shelter and medical care, are underweighted in the CPI-W, whereas less important costs for seniors, such as apparel and transportation, are given too much weighting.
According to nonpartisan senior activist organization, The Senior Citizens League, the use of the CPI-W has reduced the purchasing power of seniors' Social Security dollars by 30% since 2000. There's a very good chance that, as long as the CPI-W continues to be the program's inflationary tether, this degradation in purchasing power will continue to widen over time.