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Lawmakers Want To Change How Social Security COLAs Are Calculated

American retirees are expecting more than a change in the weather as October approaches, bringing with it the announcement of the highly anticipated cost-of-living-adjustment (or COLA) to Social Security benefits.

The Social Security Administration raises benefits every year to bring them up to speed with inflation. The boost is calculated using the average inflation rate in the third quarter (July, August and September) with an index called the CPI-W — but that could change as progressive legislators push for a switch to an experimental index they argue is more accurate.

The CPI-W tracks monthly changes in goods and services for urban wage earners and clerical workers, representing about 32% of the U.S. population. Using this measure, Social Security recipients saw a historic 8.7% COLA increase for 2023 thanks to surging costs on everyday goods and services recorded by the index. As prices cool, next year’s COLA is expected to be much lower.

In response to the waning purchasing power of Social Security payments, which average around $1,800 a month for retired workers, two bills have been introduced or reintroduced by Democratic lawmakers in 2023: the Fair COLA for Seniors Act and the Social Security Expansion Act. Both include proposals to calculate the COLA using the CPI-E, a different metric that measures price changes specifically based on the spending patterns of Americans 62 years old and over.

According to sponsors of the bills, the CPI-E more closely tracks the expenses of older people by taking expenses like prescription drugs into account.

“Using a COLA that actually reflects how retirees spend their money — especially in health care — is a no-brainer that will increase benefits and make Social Security work better for the people it serves,” Rep. John Garamendi, D-Calif., said in a news release earlier this year.

Is the CPI-E a better way to calculate the COLA?

At first glance, changing the index used to calculate the COLA may seem like an obvious fix. Why wouldn’t the government shift to a measure of inflation that takes older people’s true expenses into account, increases their monthly benefits and effectively strengthens the public safety net?

The advocacy group National Committee to Preserve Social Security and Medicare, which advocates for sweeping increases to Social Security benefits, said in a 2022 brief that the index’s adoption is long overdue.

“The CPI-E has been under review for four decades,” the committee said, adding that “it is time for the federal government to … conclude its analysis and adopt a more accurate consumer price index for the elderly.”

But economists say it’s not nearly so simple — and that legislators who want to expand Social Security may be pushing for the CPI-E on a political basis (not because it’s actually a better measurement).

Marc Goldwein, senior vice president and policy director for the nonprofit Committee for a Responsible Federal Budget, tells Money that the CPI-E doesn’t always capture price changes at the same rate as overall inflation. For 2022 and 2023, he says, a COLA calculated using the CPI-E would have been significantly lower than the actual one based on the CPI-W.

“I guarantee you nobody would be advocating the CPI-E — not a single person — if the CPI-E was going slower than generalized inflation on an ongoing basis, but that’s exactly what it’s done the last two years,” he says.

Under the CPI-E, retirees would have received about an 8% benefits increase this year as opposed to the 8.7% that the Social Security Administration ultimately calculated with the CPI-W, Goldwein adds.

The CPI-E’s flaws don’t end there, though: Goldwein says it’s not actually very good at measuring the retiree-centric costs it tracks. For one, the index is based on what Goldwein says is lesser-quality survey data due to a much smaller sample size than the CPI-W. As a result, he says, it does a poorer job of accounting for year-to-year changes in spending patterns.

Let’s say chicken becomes more expensive due to an outbreak of bird flu, leading shoppers to purchase pork instead. This is what’s known as the substitution bias — the CPI-E overestimates how much people’s costs are actually rising because it assumes that they are buying the same exact goods every year, regardless of price changes, instead of considering the possibility that they will substitute similar (cheaper) items.

The CPI-E also doesn’t take into account particulars like senior discounts or where retirees shop, according to the U.S. Bureau of Labor Statistics, and it doesn’t reflect their true housing costs. Many older Americans own their homes and have paid them off.

“It’s really heavily weighted towards housing,” Goldwein says. “The vast majority of seniors are not facing any rent, and half of seniors aren’t facing any ongoing housing costs related to [their properties].”

The factoring in of retirees’ health care costs, a key selling point of the CPI-E, can also diminish the reliability of the index as a measure of retirees’ expenses because they’re difficult to track, according to Goldwein. The difference between improvements in health care quality and inflation in health care prices can often be indistinguishable.

How using the CPI-E could impact retirees

On average, adopting the CPI-E for COLA calculations would increase Social Security benefits by about 0.2% a year, according to Goldwein. While that may sound like a win for beneficiaries, an increase in benefits without a solution to the looming insolvency of the trust fund used to bankroll Social Security could cause a ripple effect.

The Committee for a Responsible Federal Budget, which advocates for deficit reduction, has been sounding alarm bells warning of the depletion of the Old Age and Survivors Insurance (OASI) Trust Fund for years. A recent analysis from the nonprofit predicts that without a solution to the pending funding shortfall, the fund’s reserves will run out by 2033 and result in an immediate benefits reduction of $17,400 for the average newly retired, dual-income couple.

The CPI-E may even accelerate insolvency, Goldwein says, which could be particularly bad in the long term for younger retirees. So while Goldwein favors an increase in the payroll tax that funds Social Security and an increase in benefits for the poorest retirees, he says there’s not much of a case for an across-the-board benefits increase.

In addition, analysis by research initiative Penn Wharton Budget Model predicts that the CPI-E’s short-term impact on benefits may lead workers to save less and retire earlier, increasing reliance on Social Security even though it was never intended to be a primary source of retirement income.

With both the Fair COLA for Seniors bill and Social Security Expansion Act sitting in committee, it’s unclear at this stage whether Congress will reach an agreement on adopting the metric.

Regardless, this year’s calculations will be unaffected — the 2024 COLA is set to be announced next month; the most recent prediction is about 3.2%.

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