Why Social Security COLA cuts will whip up a fight

June 30, 2011

If you want to tick off a senior, just mention Social Security’s cost-of-living adjustment (COLA). The COLA has been on auto-pilot since 1975, when the first automatically-adjusted benefit adjustment was made, using a formula tied to the Consumer Price Index. A COLA was awarded every year from that time until 2008, but since then — nada.

Uncle Sam’s stinginess resulted from a quirky spike in the CPI-W — the index now used to determine the COLA — in the third quarter of 2008. Just before the economy crashed, the CPI-W spiked temporarily due to a big increase in energy prices. The result was a whopping 5.8 percent COLA for 2009. Social Security payments can’t rise until the CPI-W exceeds the 2008 level — and they can’t fall under federal law — so benefits were held level in 2010 and 2011.

A 1.1 percent COLA is forecast for 2012 by the Congressional Budget Office (CBO). But debate is heating up in Washington about further changes that could enrage seniors anew.

Several of the key federal deficit reduction plans that have been advanced in Washington recommend shifting to a measure of inflation called the “chained CPI.” A chained index reflects changes that consumers make in their purchasing across dissimilar items in response to price changes; the theory is that a spike in gasoline prices will prompt consumers to spend less on fuel, perhaps more on food. And so on.

The chained CPI could be applied to federal benefit programs and to the income tax code — although it stands to generate far more benefit cuts than revenue gains.

On the benefit side, a chained CPI would impact Social Security, civilian and military pensions and veterans’ benefits and Supplemental Security Income. On the revenue side, a chained CPI might be applied to inflation adjustments for tax brackets in the personal income tax code, effectively serving as a stealth tax hike by reducing tax bracket adjustments and subjecting more of individuals’ earnings to higher tax rates over time.

According to the CBO, benefit adjustments could yield $217 billion over 10 years, with 52 percent of that — $112 billion — coming from reduced Social Security COLAs; income tax bracket creep would generate $72 billion.

Most proposals to cut Social Security benefits push the changes far down the road, but a $112 billion bite out of Social Security COLAs would affect today’s seniors. The chief actuary of the Social Security Administration estimates that the chained CPI will rise about 0.3 percentage points less per year than the CPI-W. With compounding, that translates to a monthly benefit cut of 8.4 percent for a retiree at age 92 (calculated from age 62, the first year of eligibility), according to the National Academy of Social Insurance (NASI).

A cut in Social Security COLAs will generate red-hot controversy among seniors already livid about flat payments over the past two years, and Social Security advocates, many of whom argue we should be moving in the opposite direction on COLA policy.

They argue that the current CPI-W measure doesn’t reflect the living costs experienced by the elderly — especially healthcare costs. Healthcare inflation has far outpaced general inflation for several decades. Medicare provides fairly comprehensive coverage, but it doesn’t cover everything, and premiums have risen sharply along with the general rise in healthcare costs. NASI notes that monthly premiums for Medicare Part B (doctor’s visits), have jumped more than fifteen-fold since 1976, to $115.40 this year.

One recent study pointed to medical expenses as a major contributor to bankruptcy among seniors.

Since 1988, the BLS has maintained an experimental index, the CPI-E, which aims to reflect the spending patterns of people over age 62. Used instead of the CPI-W, it would translate into monthly benefits about six percent higher for a retiree at age 92, NASI estimates.

“Since most of the deficit reduction (that would result from using the chained CPI) comes from cutting benefit for elderly and disabled Americans, it does point one back to the question of whether the chained CPI is more accurate for elderly and disabled Americans,” says Virginia Reno, NASI’s vice president for income security. “Evidence suggests it is less accurate than a CPI for the elderly, because it fails to reflect the significantly larger role of out-of-pocket health spending by seniors and disability beneficiaries.

Proponents of a chained CPI usually describe it as a technical correction to make COLAs more accurate — and a geeky topic only an economist could love. But it actually will have major implications out in the real world, so expect COLAs to get just as fizzy as other aspects of the Social Security debate.

5 comments

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[...] Learn more in my column this week at Reuters Wealth. [...]

The chained CPI is a scam. It’s a cowardly and dishonest way to cut benefits for people who are already living on the poverty line… benefits that they paid for themselves.

Sure, when the price of steak goes up, people switch to chicken. And when the price of chicken goes up, old folks will switch to cat food.

But our brave and intelligent politicians and non partisan experts can cause that to happen and no one will notice until it’s too late to remember who did it to them.

Worse, their is NO need for any kind of a cut. No need for huge tax raises on the rich or anybody else.

Social Security is the workers paying for their own benefits. It’s not welfare. It doesn’t cost “the government” a dime.

If the next generation of workers is going to live longer than the last, they can pay for their own increased costs with a payroll tax increase of one half of one tenth of one percent per year… that’s about forty cents per week each year, while wages are rising about ten dollars per week each year, And they will get their money back, with interest.

Posted by coberly | Report as abusive

I’ve always loved the “heads old people win, tails taxpayers loose” aspect of the COLA adjustments.

Posted by Dangerman2 | Report as abusive

Speaking to coberly’s point, both Social Security Retirement and Social Security Disability (though not Supplemental Security Income) are insurance model-based programs that use basically the same (ideally) self-sufficient system as any private insurance company… that is, people pay into the system from money they have earned, and qualify to receive benefits upon retirement/disability onset based on work and payment history.

While making changes to cost of living adjustment determination methods may make sense from an economic perspective, it seems like an odd place for the government to be looking to save money compared to the many massively wasteful and inefficient ways in which the general tax fund is squandered.

Thanks for the insightful article,

Doug
Social Security Disability Help
http://www.socialsecurity-disability.org

Posted by DisabilityGuide | Report as abusive

I have to try to live on Social Security Disability and I give up more than I’d like. I live in substandard housing and buy the cheapest items in the store. No car and taxis cost a fortune. Go ahead and cut my benefits. I am a veteran and 62 years old with a heart condition and my medication even with the help of VA takes over a $100 a month of my check. What happened to the country I fought and served for? We elected idiots to office and then let them BS us in to telling us we don’t know how things run in DC. We’ll we let them do it to us and now the whole country is paying with a fool like Obama.

Posted by Sonnyjc9 | Report as abusive

The chained CPI is really the Alpo Index. It will move retirees from NY Strip to canned dog food, while telling them nothing has changed. They will end up on a Bangladeshi diet. Remember the frog in the water pot, not jumping out as the heat is gradually turned up until he is eventually cooked to death.

Why not increase the earnings of the trust fund by allowing the trustees to invest in U.S. government guaranteed debt. No increase in in risk, but a slight increase in return. Then allow the trustees to invest their funds in U.S. treasuries anywhere on the yield curve.

Retirees are already subsidizing the younger generation by getting lousy CD rates that allow the kids to get cheap mortgages.

It wasn’t retirees who caused the mortgage mess, yet Ben Bernake through 0% interest rates is forcing retirees to suffer for the kids. That is enough.

Posted by DLM706 | Report as abusive

[...] Personal finance | retirement | Social Security When should you turn on the tap that gets your Social Security benefits [...]

[...] the White House appears open to benefit cuts via adoption of a new cost-of-living-adjustment (COLA) formula called the “chained CPI,” and to higher retirement ages. Both would be benefit cuts; the big [...]

[...] but perhaps more on food. Coberly – a reader of my earlier post on this topic — offered a good summation of what it means: The chained CPI is a scam. It’s a cowardly and dishonest way to cut benefits for people who are [...]

[...] annual cost-of-living adjustment – moves that will reduce monthly benefits 20 percent and 8 percent, respectively. And they want to increase the Medicare eligibility age from 65 to [...]

[...] to be taking a hard look at cutting COLAs  by implementing a formula change using the so-called chained CPI. The chief actuary of the Social Security Administration estimates that the chained CPI will rise [...]