As debate continues over how to best adjust Social Security benefits for inflation, a leading voice in retirement research says the answer may not be so straightforward.
Since 1975, Social Security’s cost-of-living adjustments (COLA) have been based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), an index that tracks the price of goods and services in urban areas. Critics argue this tool doesn’t reflect the spending patterns of senior citizens, who would be better served if the COLA was tied to the CPI for the Elderly.
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But a paper recently published by the Center for Retirement Research at Boston College contends that changes in the cost of medical care and transportation have made the CPI-E a less viable tool for crafting policy. Instead, a new index is needed to ensure Social Security benefits keep pace with inflation and accurately reflect seniors’ spending habits, CRR researchers write.
CPI-W vs. CPI-E
To ensure that Social Security benefits retain their purchasing power in the face of inflation, benefit levels are adjusted each year. Since the adjustment is tied to the CPI-W, Social Security benefits increase as inflation rises. And with inflation reaching levels in 2021 that haven’t been seen in decades, Social Security benefits are set to rise 5.9% in January.
The CPI-E was created in 1987 to separately track the spending patterns of people 62 and older. Critics of the current system assert COLAs should be linked to the elderly index because the broader CPI-W underweights expenses seniors spend more on, like medical care and housing. As a result, the CPI-E places a higher emphasis on medical care and housing, and a lower weight on transportation, food and beverage.
The Senior Citizens League, a leading senior advocacy group in favor of using the CPI-E to determine COLAs, says Social Security benefits have lost 30% of their purchasing power since 2000 because of inadequate COLAs and rising healthcare costs.
Since 1983, the CPI-E has risen annually by an average of 2.8%, outpacing the CPI-W by 0.2% during that timespan.
But the gap between the two indexes has narrowed in recent years. In the 20 years that followed the creation of the CPI-E, the index rose almost 0.4% faster per year than its counterpart. Over the last two decades, however, the annual difference between the two indexes has shrunk to just 0.05 percentage points.
But why has the gap between the two indexes narrowed? Two major expenses: heathcare and transportation.
The CRR research indicates that medical care costs are no longer climbing as fast as once before. Between 1983 and 2002, the cost of medical care increased 2.6% faster than the CPI-W each year, while the cost of transportation rose 0.8% slower than overall index.
But those trends have since changed. On average, the cost of medical care outpaced the CPI-W by only 1.3% per year between 2002 and 2021. The cost of transportation, meanwhile, rose 0.2% faster than the CPI-W each year during that time.
“Given that older Americans spend so much of their budget on medical care relative to the population as a whole, the slowdown in cost growth substantially reduced the inflation they faced over the two periods,” Alicia H. Munnell and Patrick Hubbard wrote in the CRR paper, “What is the Right Price Index for the Social Security COLA?”
In fact, if the CPI-E had been used to calculate next year’s COLA, Social Security benefits would have only increased by 4.8% instead of 5.9%, according to Munnell and Hubbard.
“And the extraordinarily low rate of medical care price growth in the last year – 0.4% – explains why the CPI-E fell below the CPI-W,” they added.
Finding a Way Forward
The CRR research comes as Congressional Democrats aim to reform various elements of Social Security. A bill introduced in October by U.S. Rep. John Larson (D-Conn.) would overhaul how the annual COLA is calculated, tying it to the CPI-E.
“The Social Security Cost of Living Adjustment (COLA) should reflect the costs experienced by beneficiaries. Social Security 2100: A Sacred Trust directs the Bureau of Labor Statistics to develop a robust Consumer Price Index (CPI) based on the expenses seniors actually face,” Larson said in a statement. “Over the long term, the Social Security actuaries project that the CPI-E will be, on average, 0.2 percentage points higher per year than the CPI-W. Seniors groups are supportive of the CPI-E formula for the COLA, because overall, it’s what’s best for seniors.”
But CRR researchers say the CPI-E isn’t perfect. “Because the CPI-E is not constructed from scratch but rather is derived from an index for the broader population, it has a number of limitations,” Munnell and Hubbard wrote.
They contend the CPI-E is based on relatively few households so the index is subject to a larger sampling error than the CPI-W. The index also may not take into account the types of goods that seniors buy and the stores in which they purchase them, according to Munnell and Hubbard.
As a result, they say a new index is needed, especially if medical costs do not climb sharply.
“The extremely low rate of medical care inflation in the last year clearly reflected the low usage of doctor and hospital visits by the population as a whole during the pandemic and is unlikely to be repeated,” the researchers wrote.” But if the rate of medical care inflation continues to be held in check, as it has for the last two decades, then the argument for using the CPI-E weakens.”
Bottom Line
How annual cost of living adjustments are calculated for Social Security beneficiaries remains a controversial and important issue. While a bill seeks to tie the annual increases to an index that tracks inflation for seniors, the Center for Retirement Research says an entirely new index would need to be created. With the cost of medical care rising more slowly than in previous decades, seniors now face less inflation than once before. If the CPI-E dictated annual COLAs, next year’s history 5.9% increase would have been only 4.8%, according to the CRR.
Tips for Making the Most of Social Security
- While you’ll be eligible for Social Security at age 62, you won’t be able to claim your full benefit until you reach full retirement age. After that point, you benefits will increase with each month you delay claiming them. SmartAsset’s Social Security Calculator can help show you how much you benefits will be worth at different ages.
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