Adjusting Social Security Benefits for Changes in the Cost of Living

Abstract

This brief examines different price indices that might be used to adjust Social Security benefits for changes in the cost of living. The currently used consumer price index for wage and clerical workers (CPI-W) is probably biased upward. A new experimental "chain" index removes some of the upward bias and therefore rises more slowly. Using it would help solve some of Social Security's long-run financial problems. Another candidate is an experimental index designed to reflect the purchases of the elderly. Largely because it heavily weights health costs, it is likely to rise faster than the CPI-W.

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Introduction

Late last year Social Security recipients were shocked to hear there would be no cost-of-living adjustment (COLA) for their 2010 benefits. Many complained, even though government statisticians had decreed there had been no increase in the cost of living. It was the first time without a COLA since benefits were first indexed for inflation in the early 1970s.

This rare episode drew attention to how we adjust government benefits and our income tax system for changes in living costs. The adjustment process can only provide an approximation, because there is no such thing as a cost-of-living index. The consumer price index (CPI) is used to make COLA adjustments and the Bureau of Labor Statistics (BLS) does its best to make the CPI an approximation of the cost of living. They have made significant improvements in recent years, but they will never attain perfection.

Basically, we would like to know how many dollars it takes to attain a given level of well-being and how the amount changes from month to month and from year to year. Given that well-being is an intensely personal concept and is not really measurable, no simple index can be used to adjust accurately for changes in living costs.

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