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Social Security COLA: Which Inflation Adjustment Is Best?

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Senior citizen activists and others who oppose using the chained CPI-U to calculate the Social Security cost-of-living adjustment (COLA) just got some government support for their argument.

The Government Accountability Office studied hypothetical COLA levels over the 30 years from 2003 to 2033, using calculations linked to the Chained Consumer Price Index for All Urban Consumers (CPI-U), the CPI-E (the E stands for elderly) and the CPI-W (for Urban Wage Earners and Clerical Workers), which is the current standard.

It found that that the COLA would decrease by an average 0.25% per year if the Chained CPI-U were used instead of the CPI-W, and the total loss would top 7% after 30 years.

Using the CPI-E as the COLA link, in contrast, would increase payouts by more than 4% over the same 30-year period.

The GAO also found that the impact of these changes from the CPI-W standard to calculate COLAs would be greatest for low-income retirees and smallest for high-income Social Security beneficiaries.

According to the study, by 2033 a hypothetical 65-year-old in 2003 with earnings equal to the national average wage index ($33,256 in 2003) would collect $165 less per month if the COLA were linked to the chained CPI-U rather than the current CPI-W. That equates to about $2,000 less that year.

That same hypothetical senior receiving a COLA linked to the CPI-E would see his or her monthly benefit increase more than $100 by 2033, which equates to an additional $1,300 in benefits that year.

The GAO report notes that the Office of the Chief Actuary at Social Security assumes that the CPI-E would increase future payouts by 0.2 percentage points more than the CPI-W and that the chained CPI-U would reduce payouts by 0.3 percentage points compared to the CPI-W.

(Related: Social Security COLA for 2019: 2.8%)

The GAO undertook the study in response to a request from two Republicans in Congress, Reps. Virginia Foxx of North Carolina and Tim Walberg of Michigan, but the issue of changing the index used to calculate the Social Security COLA is not new.

More on this topic

For years, Washington politicians have proposed using chained CPI-U as the inflation adjuster for social programs including Social Security. Several bipartisan deficit reduction plans, including Bowles-Simpson, Domenici-Rivlin and the Gang of 6 plan, would have converted programs using CPI-U or CPI-W to chained CPI.

Even former President Barack Obama supported using chained CPI-U in his 2013 budget proposal but eventually dropped the idea.

Proponents of chained CPI argue that this index more accurately depicts the prices that consumers pay for goods and services as they substitute cheaper goods and services for more expensive ones. As a result, It would also save the government money.

Opponents, like Mary Johnson, Social Security and Medicare policy analyst at The Senior Citizens League, favor using the CPI-E instead for social programs focused on seniors, arguing that it more accurately reflects their spending patterns, often dominated by health care and prescription drug costs.

The Bureau of Labor Statistics considers the CPI-E an experimental measure, which would cost the agency about $5 million per year over several years to research before it could produce an official CPI-E index ready to use. In addition, Social Security officials indicated to the GAO that any change to its COLA calculation would require legislative action.

(Related: Beware the Chained CPI Link in the New Tax Law)

This argument to switch to chained CPI is not theoretical. Chained CPI-U is the inflation adjuster included in the tax cut legislation of 2017, which links marginal personal tax rates, credits and the standard deduction to the chained CPI-U. As a result, taxpayers will move more quickly into higher brackets as their incomes rise, but the tax credits they receive and standard deduction they take will rise more slowly.

The GAO similarly estimates “that a switch to the chained CPI-U would lower benefits through small annual changes that accumulate over time, relative to using the CPI-W, whereas a switch to the CPI-E would increase benefits in a similar manner.“

— Check out Social Security: 12 Things Everyone Should Know on ThinkAdvisor.