Social Security adjusts benefits to keep pace with price increases. Otherwise, benefit purchasing power would erode. In the 1970s, Congress legislated yearly "cost-of living adjustments" (COLA) to regularize benefit boosts and provide predictable and objective criteria for them. COLA is an invaluable feature of Social Security. Practically no private pension plans and state and local retirement programs provide comparable protection. Such plans cannot because they lack sufficient numbers of participants and a sufficiently long time horizon to balance out favorable and unfavorable periods of investment earnings and other variables. Some few plans provide adjustments that only partially mirror price increases and frequently pull back when the economic going gets rough.
Social Security COLA is calculated as the difference between the price of a "market basket" of goods and services typical of purchases by urban workers for the most recent year and the price of the same basket the year before. That percentage increase is applied to each recipient's benefit for the year starting the following January. (Go through that one more time so that you get it.)
This design inevitably means that current benefits, adjusted for past price increases, will always lag behind current year prices which chronically tend to increase. For example, this year (2011), fuel and food prices have been rising substantially; but the COLA calculated in 2010 did not, nor could, offset them. The COLA response to 2011 price boosts will start in January 2012; but that COLA will not ameliorate prices that increase during 2012. Far from overstating inflation, COLA always is a year behind. Alas, few prices go down.
Further, as we get older, earlier sources of income -- such as paid employment and benefits from other retirement plans, if any -- shrink. And those that continue -- such as pension benefits for the lucky minority, do not adjust for price increases fully, if at all. On top of that, as we get older, our ability to provide goods and services for ourselves degrades.
Currently, some Republican self-styled "reformers" propose to reduce COLA claiming that the current method of calculating it overstates inflation. They argue that using the same market basket items each year ignores consumer substitutions of equivalent but lower-cost items. So, the new, supposedly more accurate, measure -- which they call "chained COLA" -- would reduce the benefit under the current formula by an additional .03% (3/10ths of one percent) every year. That utterly arbitrary new element suggests that the name of the game is simply to reduce each year's COLA and to do it by what they regard as unnoticeably minute amounts. But such a conclusion, made by people with current jobs and full stomachs, does not capture how detrimental any reduction would be for beneficiaries.
Social Security is the largest part of income for most recipients; for almost 80% of them, it is half or more; for 60%, it is more than half; for 30% of recipients, it is all of their income, according to the report, "Fixing Social Security: Adequate Benefits, Adequate Financing". To those heavily dependent on Social Security's modest benefits, which average $1100 a month, small subtractions would hurt, while for those currently employed with a reasonably good income, such reductions may seem too small to worry about. But those "small" reductions accumulate. After 5 years of the "chained COLA", benefits would be 1.5 % behind price increases; after ten years, 3%. After 20 years, the benefit reduction would be a whopping 6%.
Moreover, the chained COLA rationale, that we substitute lower cost goods when prices go up, is unrealistic. How many of us monitor the price we paid for the many dozens of things we regularly buy? How many of us spot their varying prices, especially when camouflaged by the ploys marketing experts? What chance do most of us have to compare the price effect of a product measured in pounds or ounces when it is offered in grams? How many of us with bi-focals and tri-focals can even read price information at the bottom edge of the bottom shelf? Chained price substitution may occur in the minds of staffs bent upon finding a result but does not occur in the minds of shoppers in supermarket aisles. Beyond that, chained changes take experts two years to monitor for the purpose of actually applying to an official COLA.
Republicans regularly assure retirees and those over age 55 that they will be exempt from any benefit reductions. But the proposal by the Commission on Fiscal Responsibility co-chairs advocated the use of this "chained COLA" with no mention of delay or exemption for those at or near retirement. So far, Republican leaders have kept the chained COLA behind their back. But, be on guard. This COLA scam could be sprung toward the end of budget negotiations when mobilizing opposition would be difficult. Well, old timers -- and the millions of younger family members and friends who care about you -- insist that the Republican "reformers" take that trap off the table.