North Carolina Cooperative Extension

You Decide: What's the best COLA

By Mike Walden | Feb 01, 2013

 

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!

 

Dr. Mike Walden is a William Neal Reynolds Professor and North

Carolina Cooperative Extension economist in the Department of

Agricultural and Resource Econo

Comments (2)
Posted by: Beth G. Johnson | Feb 05, 2013 17:01

First, I would like to thank Dr. Walden for a very clear explanation of a complicated issue.  Second, I totally agree with the attempt to slow down the raises that Social Security is giving out.  The COLA should be the lower 'chained' system.  NC's working teachers did not receive a raise for over 2 years and then when they did get a raise it was totally used up by the increase in health insurance costs.  How can senior citizens complain that their raises are too small?

Beth G. Johnson



Posted by: Charles Zimmerman | Feb 06, 2013 10:21

    I also agree that this was a very good article. However, I recognize that the so-called cost of living assessments have been inadequate to address the entirety of the issues SS recipients face. I.E. not every region of the country is the same nor are all recipients. While We the people cannot address all the inequalities, We have an obligation to support original intent of SS.

      To adequetly take all circumstances in consideration, the "cola" that has the greatest measured value or cost, depending on your outlook, must be used. If We can rebuild Iraq & Afghanistan's roads, infrastructure, hospitals, etc, etc, We can surely take care of OUR own, especially as most have paid for SS for a long time at great cost to themselves. And! there are a great many who expired before their paid-up bennefits were used in their entirety or used at all.

       Also, at present SS deductions stop at $100,000.00(app) in income. This is ridiculous. It is just another means the wealthy shift their burdon onto those not so fortunate. True equality it is not. Irresponsable it is. Certainly doesn't meet the standards of John Locke or OUR Founders.

I am retired and on no "entitlements" whatsoever.

 

Chuck Zimmerman



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