The big day has finally arrived! Oct. 10 was the release date for the U.S. Bureau of Labor Statistics’ September inflation data, which contains the last puzzle piece needed to calculate Social Security’s cost-of-living adjustment (COLA) for 2020. The official number is a 1.6% “raise.” But how do they get to that number?
It wasn’t plucked out of thin air, as it was back in the 1950s. Rather, Social Security’s COLA is tethered to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), and has been ever since 1975. The CPI-W has eight major spending categories with their own respective weighting that helps to determine the movement in price of a predetermined basket of goods and services. Perhaps the most interesting aspect of the COLA calculation is that very few monthly CPI-W readings are actually used. Only readings from the third quarter (July through September) factor into the COLA.
To determine the following year’s COLA, the Social Security Administration simply takes the average CPI-W reading from the third quarter of the current year and compares it to the average reading from the third quarter of the previous year. If the average has risen from one year to the next, it implies that inflation has taken place. In such an instance, beneficiaries will receive a “raise” that’s commensurate with the year-over-year percentage increase, rounded to the nearest tenth of a percent. In the rare instance that the reading declines from one year to the next, signaling deflation, benefits remain static. This has only happened on three occasions (2010, 2011, and 2016).
What does this mean for the pocketbooks of Social Security beneficiaries? Based on the fact that the average retired worker and disabled worker were bringing home $1,473 and $1,236, respectively, a month as of August, a COLA of 1.6% should lead to a raise of about $24 a month for retirees and a little under $20 a month for the long-term disabled. But the celebration is somewhat muted when you consider the fact that COLA has regularly failed to keep up with the actual inflation rates that seniors have been contending with since the start of the century.
The problem is that the CPI-W just doesn’t do a good job of measuring the costs that matter to retired workers. That’s because, as the index’s name implies, it’s tied to the spending habits of urban and clerical workers, who happen to spend their money very differently than retirees. Thus, the CPI-W ignores the fact that seniors aged 62 and over comprise more than four out of five current program beneficiaries. This leads to an underweighting of truly important expenses, such as medical care and housing, and an overweighting of less important costs to seniors, such as education, apparel, and transportation.
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