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You Decide: What's the best "COLA"?
Story Date: 2/1/2013
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Source: Dr. Mike Walden, NCSU COLLEGE OF AG & LIFE SCIENCES, 2/1/13
A COLA war is going on. It hit the headlines a couple of months ago,
has now subsided but is threatening to come back. It’s a war that not
only can affect those who enjoy liquid refreshments but potentially
everyone!
So is this a war between the big-name soda manufacturers? Actually,
it’s not. I’m not talking about the best-tasting or most
thirst-quenching carbonated beverage. Instead, I’m referring to the
best “cost-of-living adjuster”!
Now, before you tune out, let me remind you, this version of the COLA
war has the potential to affect everyone. This is because the front
where the war will be waged is Social Security, and 90 percent of us
are in the Social Security system. So using a popular current phrase,
virtually all of us have some skin in this fight.
But just what is this COLA war? It’s a discussion (war is really too
harsh a term) about the best index to use to adjust future Social
Security payments received by retirees.
When Social Security was introduced in the 1930s, payments to retirees
were not periodically changed to keep up with the cost of living. This
didn’t begin until the 1970s, when price inflation started to be a big
problem. Now, each year retirees receiving Social Security receive an
increase in the amount they receive based on how some broad increase
in average prices has changed.
This annual adjustment in Social Security payments is a big help to
retirees. Even though the annual change can be small, over time it can
accumulate to an impressive gain. For example, if a 3 percent increase
is received each year for 10 years, then after a decade, the Social
Security recipient’s checks will be more than one-third (with
compounding) higher.
However, the big question is, What method should be used to make the
annual adjustments to Social Security payments? Currently, the
government uses its main inflation gauge -- the Consumer Price Index,
or CPI -- to make these adjustments.
The CPI tracks prices in a “market basket” of products and services
typically bought by households. The prices are weighted by their
relative importance to households’ overall spending -- meaning, for
example, gasoline gets a larger weight than a can of peas -- and then
the weighted prices are averaged and converted to an index for ease of
comparison. So, for example, a CPI of 200 compared to a CPI of 100
indicates weighted average prices have doubled. CPI values can be
found at www.bls.gov.
So the CPI sounds reasonable, right? Not everyone agrees. One
criticism has been that changes in the CPI won’t reflect how prices
change for every household, because people differ in what they buy in
their market basket.
Of course, this is correct, but we shouldn’t expect the government to
have a customized CPI for every household. However, while conceding
this point, retired households have long complained that their
spending patterns do markedly differ due to the larger proportion
spent on medical care. This has led to calls for a special “senior
citizen CPI” to adjust Social Security pensions.
But the new COLA conflict is over a different issue. It has to do with
how frequently the market basket is updated. The current CPI assumes
that what we buy changes infrequently, approximately every two years.
Of course, this is unrealistic. Therefore, a revised CPI -- the
“chained CPI” -- has been developed. It is designed to reflect changes
in household buying over time due to two factors: as new products are
introduced or buying preferences change and as we shift out of
products and services where prices have risen to products and services
where prices have fallen or remained stable.
It’s the last factor that has created the controversy. Say the price
of gasoline jumps. The traditional CPI would assume we would continue
buying the same gallons of gasoline, so the full impact of the gas
price increase would be reflected in the CPI.
Yet under the new chained CPI, there would be an assumption we would
purchase slightly fewer gallons, so the “weight” in the gasoline
component of the CPI wouldn’t be as large as with the traditional
method.
This means inflation with the chained CPI will be more modest, and
programs like Social Security will save money because pensions to
retirees will rise at a slower pace. Indeed, calculations suggest
Social Security could save more than $100 billion over the next decade
if the chained CPI is used to adjust future payments.
This has led some to claim that using the chained CPI for the Social
Security COLA would mean a cut in payments for retirees. Other say,
no, it’s merely a more realistic COLA that will extend the life of
Social Security.
Since I’m now eligible to receive Social Security, I’ll be watching
this COLA war if it is renewed. So, what’s the right COLA for you? You
decide!
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