Social Security's importance to the financial well-being of retirees is undeniable.
In April, national pollster Gallup conducted its 22nd annual survey of retired workers to gauge how reliant they are on the Social Security income they receive. A whopping 59% noted that it represents a "major" source of income, with another 29% counting on it as a "minor" income source. Just 1 out of 10 seniors claimed they didn't require their Social Security benefit to cover their expenses. For 22 years, between 80% and 90% of retired workers have leaned on their Social Security payout in some capacity to make ends meet.
It's this reliance on Social Security income that makes the annually announced cost-of-living adjustment (COLA) so important to the program's more than 49 million retired workers.
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Social Security's cost-of-living adjustment (COLA) passes along "raises" to beneficiaries
Social Security's COLA is the "raise" passed along to the program's beneficiaries most years to account for inflation. In other words, if the price for goods and services climbs, Social Security benefits should, in a perfect world, rise by a commensurate amount to ensure that the program's more than 66 million total beneficiaries don't lose purchasing power.
You'll note I've put "raise" in quotation marks. This is to reflect that the benefit increase passed along most years is to match the calculated rate of inflation and not outpace it. That compares to a true raise you'd get through an employer, which may outpace the prevailing inflation rate.
Although Social Security has been doling out monthly checks to retired workers since January 1940, the methodology of accounting for inflation has been night-and-day different before and after 1975. Prior to 1975, special sessions of Congress were needed to pass arbitrary cost-of-living adjustments. During the 1940s, beneficiaries didn't receive a single COLA.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been the tool used to calculate inflation on an annual basis for Social Security. The CPI-W has a large, predetermined basket of goods and services, each with their own respective weightings. Each category having a weighting allows the CPI-W to be expressed as a single number, which makes for easy comparisons to the previous month or year.
Calculating Social Security's COLA is easy, too. The CPI-W readings from the third quarter of the current year (July September) are compared to the CPI-W readings in the third quarter of the previous year. If the average CPI-W reading in the current year rises from the average reading in the previous year, beneficiaries are due a "raise" in the upcoming year. The amount of the raise is simply the year-over-year percentage increase in the average CPI-W, rounded to the nearest tenth of a percent.
The average Social Security beneficiary is missing out on more than $6,200 in annual income
With a tried-and-true inflationary tether like the CPI-W that covers a broad array of spending categories, the assumption would be that Social Security's more than 66 million recipients are getting a fair and representative COLA each year. But dig into the numbers since the start of the century and you'll find this isn't the case.
A soaring inflation rate led to a record jump in nominal-dollar Social Security payouts in 2023. US Inflation Rate data by YCharts.
Last month, The Senior Citizens League (TSCL), a nonpartisan senior advocacy group based in Alexandria, Virginia, released its early projection for the 2024 COLA. TSCL's forecast calls for a 3.1% cost-of-living adjustment next year, which would increase the average retired workers' monthly check by nearly $57. This increase comes on the heels of an 8.7% COLA in 2023, which boosted the average retired workers' payout by a record $146 per month.
However, as TSCL has pointed out, an 8.7% COLA is a rarity. More often than not, the actual rate of inflation seniors face outpaces the near-annual "raise" they receive from Social Security.
In the same May 2023 report where TSCL offered its forecast for the 2024 COLA, it also compared and contrasted aggregate COLAs since January 2000 to the actual rate of inflation seniors have dealt with over the past 23 years (through February 2023) based on a variety of common expenses for older Americans. What TSCL found was that aggregate COLAs are up 78% since January 2000, while the cost of goods and services typically purchased by retirees rose by 141.4% over the same time frame. As a whole, the purchasing power of Social Security income has plummeted 36% in 23 years.
In 2000, the average Social Security benefit clocked in at $816 per month. Using this as the baseline figure, a 78% aggregate increase in COLAs would lead to a monthly check of $1,452.48 by February 2023. To simply keep pace with the rising cost of goods and services commonly purchased by older Americans, TSCL estimates monthly payouts would need to be $1,969.82 (i.e., 141.4% higher than in 2000).
That's $517.34 each month, or $6,208.08 each year, that Social Security beneficiaries have been seemingly cheated out of since the start of the century.
Image source: Getty Images.
This Social Security shortcoming has no easy fix
How does a seemingly straightforward inflation measurement like the CPI-W miss so badly? The answer can be found by digging into the nuts-and-bolts of what the CPI-W measures.
As its full name shows, the CPI-W tracks the spending habits of "urban wage earners and clerical workers." The vast majority of urban wage earners and clerical workers aren't senior citizens, nor are they receiving a Social Security check. Even though 56.5 million of the program's beneficiaries were 62 or older, as of December 2022, the inflationary measure determining annual cost-of-living adjustments is based on the spending habits of working-age Americans.
The issue with the CPI-W is that it's underweighting important expenses for seniors. For instance, seniors devote a higher percentage of their monthly expenditures to shelter and medical care costs than the average American. Comparatively, other spending categories, such as apparel, education, and even transportation, are of less importance. With the CPI-W, shelter and medical expenses aren't receiving enough weighting, which has resulted in this roughly $6,200/year shortfall in payouts over the past 23 years.
Although lawmakers from both parties are well aware that the CPI-W is flawed, replacing it won't be easy.
Democrats prefer swapping out the CPI-W with the Consumer Price Index for the Elderly (CPI-E). As its name suggests, the CPI-E would track the spending habits of households with persons aged 62 and over. Though this would, almost certainly, be a more accurate measure of inflation for beneficiaries as a whole, it would also increase annual COLAs and potentially strain a program that's already facing a $22.4 trillion funding shortfall through 2097, according to the 2023 Trustees Report.
Meanwhile, Republicans want to ditch the CPI-W in favor of the Chained Consumer Price Index (CPI). The Chained CPI takes into account substitution bias. If the price of a good or service rises too much, substitution bias suggests consumers will trade down to a similar but less-costly good or service. With the Chained CPI, annual COLAs would likely fall further than with the CPI-W.
Since neither party has been willing to find common ground with their opposition, no progress has been made tackling this Social Security shortcoming. In other words, expect this loss of purchasing power to worsen more years than not.
