Changes Ahead for the Social Security COLA?

One Would Raise it, One Would Lower it

People celebrating the 75th anniversary of Social Security
70th Anniversary Of Social Security Marked. Alex Wong / Getty Images

Does the annual Social Security cost-of-living adjustment (COLA) truly keep up with the basic costs of living? Many say it does not and should be increased. Others say the COLA increase is actually too high on average and should be decreased.

There are at least two ways the U.S. Congress might change the way the COLA is calculated: One to increase it, the other to decrease it.

Background on the COLA

As created by the Social Security Act of 1935, retirement benefits are intended to provide enough income to cover only the recipient’s basic costs of living or what the Act called the “hazards and vicissitudes of life.”

To keep up with those costs of living, Social Security has since 1975 applied an annual cost-of-living adjustment or COLA increase to retirement benefits. However, since the size of the COLA can be no more than the general rate of inflation as determined by the consumer price index (CPI), there is no COLA added in years during which inflation does not increase. The theory being that since the nationwide costs of living did not increase a Social Security COLA increase is not needed. Most recently, this has happened in 2015 and 2016, when no COLA increase was applied. In 2017, a COLA increase of 0.3% added less than $4.00 to the average monthly benefit check of $1,305. Prior to 1975, Social Security benefit increases were set solely by Congress.

The Problems with the COLA

Many seniors and some members of Congress argue that the regular CPI – the nationwide average price of consumer goods and services – does not accurately or adequately reflect the higher than normal, often health-related, costs of living faced by older persons.

On the other hand, some experts contend that COLA increases as currently calculated tend to be too high on average, which could hasten the total depletion of the fund from which Social Security benefits are paid, now projected to happen by 2042.

There are at least two things Congress might do to address the Social Security COLA issue. Both involve using a different price index to calculate the COLA.

Use an ‘Elderly Index’ to Raise the COLA

Advocates of an “elderly index” argue that the current COLA calculation based on the consumer price index fails to keep pace with the inflation rate faced by seniors, primarily resulting from their higher than average annual out-of-pocket health care costs. An elderly index COLA calculation would take into account those higher than average health care costs.

Experts predict that the elderly index would initially increase the COLA by an average of about 0.2 percent. However, the higher COLA under an elderly index would have a compounding effect, increasing the COLA benefit by 2% after 10 years and 6% after 30 years.   

Experts predict that the annual COLA would be on average 0.2 percentage points higher under this formula. For example, if the current formula would produce a 3 percent annual COLA, the elderly price index might yield a 3.2 percent COLA. In addition, the effect of a higher COLA would compound over time, increasing the benefit by 2 percent after 10 years and 6 percent after 30 years. Permanently increasing the size of the benefit adjustment every year would increase the funding gap by about 14 percent.

However, the same experts admit that raising the size of the COLA every year would increase the Social Security funding gap – the difference between the amount taken in through Social Security payroll taxes and the amount paid out in benefits – by about 14 percent.

Use a ‘Chained CPI’ System to Lower the COLA

To help close that funding gap, Congress could direct the Social Security Administration to use the “chained consumer price index” to calculate the annual COLA.  

The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) formula better reflects the actual buying habits of consumers relative to changing prices. Basically, the C-CPI-U assumes that as the price of a given item goes up, consumers will tend to buy lower-priced substitutes, thus keeping the average cost of living lower than that calculated by the standard consumer price index.

Estimates show that applying the C-CPI-U formula would initially decrease the annual COLA by an average of 0.3 percent. Once again, the effect of a lower COLA would compound over the years, reducing the benefit by 3% after 10 years and 8.5% after 30 years. Social Security has estimated that applying the C-CPI-U to reduce the size of the COLA benefit would eventually decrease the Social Security funding gap by about 21 percent.