Today, nearly 65 million people receive a Social Security benefit each month, and more than 46 million of them are retired workers. For many retirees, Social Security plays a critical role in providing a financial foundation and ensuring they can make ends meet.
There's perhaps no announcement more important to these seniors each year than the October release of Social Security's cost-of-living adjustment (COLA). Think of COLA as the payout increase passed along to the program's recipients each year that's designed to true-up benefits with inflation (i.e., the rising cost of goods and services).
The purchasing power of Social Security income has been shrinking for two decades
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the program's inflationary tether. The CPI-W has eight major spending categories and dozens upon dozens of subcategories, each with their own respective weighting. These categories and subcategories track changes in the price of a predetermined basket of goods and services, thereby allowing the Bureau of Labor Statistics (BLS) to report a neat and concise single figure each month that measures inflation/deflation, as a whole.
As you might recall, on Oct. 13, the BLS released its September inflation data, which was the last puzzle piece that the Social Security Administration needed to announce the COLA for the upcoming year. The 1.3% benefit increase for 2021 ties for the second-smallest positive COLA of all time.
After averaging roughly 3% between 1990 and 2009, Social Security COLAs have plummeted since the Great Recession. Since 2009, the average annual COLA has been 1.4%. This period of time includes three years where no COLA was passed along, the smallest positive COLA on record (0.3%), and the noted 1.3% COLA for the upcoming year.
The fact is, the CPI-W doesn't do a very good job of tracking the inflation that retirees are facing. That's because, as its official name states, it's an index that's designed to track the spending habits of urban and clerical workers. These are almost always working-age Americans who aren't receiving a Social Security benefit.
Essentially, the most important social program for seniors is having its annual COLA determined by the spending habits of working Americans whose expenditures are markedly different from retired workers. It's this disparity that's led to the loss of Social Security income purchasing power for retired workers over the past two decades.
The Chained CPI would be even worse news for seniors' pocketbooks
While there's little question the CPI-W is flawed, things could actually get worse for seniors with regard to the purchasing power of their Social Security dollars. You see, one of the very few things Democrats and Republicans on Capitol Hill agree on when it comes to Social Security is that the CPI-W is flawed. However, their approaches to resolve the CPI-W's shortcomings are from opposite ends of the spectrum.
Democrats would prefer replacing the CPI-W with the Consumer Price Index for the Elderly (CPI-E). Unlike the CPI-W, which tracks the spending habits of working-age Americans, the CPI-E would specifically track how households with seniors aged 62 and over spent their money. Presumably, this would result in a more accurate annual COLA measurement.
Meanwhile, Republicans favor the Chained Consumer Price Index (CPI). The chained CPI takes into account the idea of substitution bias -- i.e., trading down from a pricey good or service to one that's less expensive. For example, if the price of ground beef has risen 40% in a year, consumers might opt to purchase chicken or pork because they're cheaper. That's substitution bias in action.
The issue with the Chained CPI is that, over time, it would reduce Social Security benefits even more than the CPI-W.
In December 2018, the Congressional Budget Office (CBO) released an analysis of what would happen if, hypothetically speaking, the Chained CPI was used as the measure of inflation to index Social Security and other mandatory programs. The CBO's analysis found that, between 2019 and 2028, Social Security's COLA-based outlays would decline by an aggregate of $134.1 billion.
At the individual beneficiary level, the CBO estimates that the Chained CPI would reduce monthly benefits paid in 2028 by approximately 2.2%. Taking into account that the average retired worker monthly payout was $1,503 to begin 2020, and making the assumption that COLA will average 2% over the next eight years -- 2% is the target inflation rate set by the Federal Reserve -- the average retired worker should be paid $1,761 a month by 2028, using the CPI-W. If this benefit is reduced by 2.2% with the Chained CPI, retired workers would be looking at a monthly payout cut of almost $39, or an annual reduction of around $465 a year.
Over time, the Chained CPI would act as a stealthy tool to reduce Social Security's outlays.
Don't expect a move away from the CPI-W anytime soon
For those of you now fretting that the Chained CPI could be implemented in place of the CPI-W, relax. There's very little chance for Republicans to get their preferred inflationary measure through Congress, especially since they don't currently control the House of Representatives.
But by this same token, Democrats also have virtually no chance of replacing the CPI-W with the CPI-E. Even though the CPI-E would lead to higher COLAs over the long run, the CPI-E remains an experimental measure in need of refining, and it wouldn't have the requisite votes needed to pass in the Senate.
Long story short, the CPI-W isn't going anywhere anytime soon, and the upcoming election isn't going to change that. Without some form of bipartisan cooperation in the Senate, any attempts to switch away from the CPI-W are going to be stymied. For the 62% of retired workers who rely on Social Security for at least half of their monthly income, the purchasing power of their Social Security dollars is expected to continue declining.