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2 Ways Social Security's COLA Is Failing Seniors

Sean Williams, The Motley Fool

This has been a pivotal month for the more than 62 million people receiving a Social Security benefit check. Less than two weeks ago, the Bureau of Labor Statistics (BLS) released September's inflation data, giving the Social Security Administration the final data point needed to calculate the 2019 cost-of-living adjustment, or COLA. Think of COLA as the "raise" that beneficiaries receive each year to account for the inflation that they've faced.

Next year, thanks to healthy energy and shelter inflation, Social Security recipients can expect their benefits to increase by 2.8%, which is the largest COLA passed along since 2012.

A worried senior man with his hand on his forehead.

Image source: Getty Images.

Social Security's COLA is letting seniors down

But, truth be told, Social Security's annual COLA is failing the group of people it was most designed to protect: senior citizens.

According to an analysis from The Senior Citizens League (TSCL), the purchasing power of Social Security dollars has declined by 34% for seniors since the year 2000. Put in another context, what $100 in Social Security income used to buy in 2000 now buys $66 worth of those same goods and services. That's not how COLA is supposed to work.

The reason seniors have been shortchanged by the program has to do with two inherent flaws with Social Security's inflationary tether.

1. The CPI-W is focused on the wrong group of people

The program's inflationary measure that determines COLA is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). It's designed to measure price fluctuations for eight major spending categories and a laundry list of subcategories, resulting in the raise that beneficiaries receive in the upcoming year.

The problem with the CPI-W is that it's focused on the wrong group of people. Despite retired workers comprising about 70% of all recipients, the CPI-W measures the spending habits of urban and clerical workers, who, as you might guess, are typically of working age and not receiving a Social Security check. Because urban and clerical workers spend their money differently than senior citizens, it leads to important categories for seniors receiving less weighting and less important expenditures receiving added weight.

A senior's hand tightly holding a Social Security card.

Image source: Getty Images.

For instance, even though the comparison is a bit dated (December 2011), a side-by-side look by the BLS at the CPI-W and Consumer Price Index for the Elderly (CPI-E), an inflation measure that specifically focuses on the expenditures of households with persons aged 62 and over, found that seniors spend twice as much on medical care, as a percentage of total expenditures, relative to the aggregate weighting for medical care in the CPI-W. As a whole, medical care and housing expenses are underrepresented for seniors, whereas less important costs like education, apparel, and transportation, are giving more priority by the CPI-W.

In short, it sets seniors up for failure by passing along an inadequate COLA.

2. Only a small piece of the pie is considered for inflation purposes

The other piece of the puzzle is that the COLA calculation isn't taking into account the full picture.

Social Security's COLA only takes into account previous year and current year CPI-W readings from the third quarter (July through September). The average reading from the third quarter of the previous year serves as the baseline, while the average reading from the third quarter of the current year is the comparison. If the average CPI-W reading rises from the previous year, then beneficiaries receive a raise that's commensurate with the percentage increase, rounded to the nearest 0.1%. If prices fall, which has only happened three times since 1975 (2010, 2011, and 2016), then benefits remain static.

An accountant chewing on a pencil while reviewing figures on a calculator printout.

Image source: Getty Images.

In other words, COLA completely disregards year-over-year inflation changes the other nine months out of the year. This is notable because the three months that are taken into consideration involve peak hurricane season, which can disrupt oil and gas production and refining, thereby leading to higher energy costs and a beefier COLA some years. This is what happened when Hurricanes Harvey and Irma impacted the U.S. last year.

However, hurricanes are unpredictable, meaning lawmakers have seemingly banked on energy prices providing the bulk of the inflation to push COLA higher each year. It won't always work that way, and it makes the COLA calculation that much more inaccurate for seniors.

Congress can't agree on much

To add some icing on the cake, despite being well aware of the flaws with Social Security's COLA, lawmakers on Capitol Hill are in no position to fix it. That's because neither party can agree on a COLA replacement.

Democrats would prefer to implement the aforementioned CPI-E, which would presumably do a better job of accounting for medical care and housing expenses and thereby pass along a more accurate annual COLA. According to TSCL, it would also result in a higher average annual COLA.

The facade of the Capital building in Washington, D.C.

Image source: Getty Images.

Republicans much prefer the Chained CPI, which takes into account substitution bias. If you've ever traded down to a similar good or service because it was cheaper, this is a perfect example of substitution bias. Though it describes a real-world consumer behavior, it would result in lower annual COLAs than seniors are already receiving.

With absolutely no incentive for either party to work with their opposition, the CPI-W and its two major flaws are likely to remain the program's inflationary tether for a while longer.

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