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Social Security's COLA Needs to Be More Accurate

Posted By David C. John On July 11, 2011 @ 1:04 pm In Economics | Comments Disabled

Any budget agreement should include an improvement of the accuracy of Social Security’s annual cost-of-living allowance (COLA) payments. Press reports say this is now on the table.

COLAs are designed to protect retirees against inflation eroding the value of their benefits, but the index used to calculate those payments is inaccurate and overstates inflation by about 1 percentage point a year. Back in 1996, a commission led by economist Michael Boskin [1] proved this, and since then, experts have been pushing for a more accurate measure. A more accurate measure would not reduce any retiree’s Social Security payment; it would only improve the accuracy of inflation protection.

The problem arose when COLAs were first added to Social Security payments back in 1972, because the Bureau of Labor Statistics used only one index. While it has improved since then, that same index (known as the Consumer Price Index for All Urban Consumers, or CPI–U) is still being used today, despite the fact that other more accurate indices are now available.

In the budget talks, Administration officials and some congressional negotiators are rumored to be discussing using a “chained” version of that index instead. CPI–U is based on a survey of about 85 percent of the population, but it assumes that everyone will buy exactly the same amount of exactly the same items regardless of how prices change. Thus, if the price of apples goes up but the price of oranges drops, the current CPI–U assumes that consumers will still buy the same quantities of each. However, a chained index, C–CPI–U, adjusts quantities—knowing that if the price of apples increases, people will buy fewer apples and more oranges. This results in a more accurate measure.

The use of a chained CPI has been endorsed by the Simpson–Bowles deficit commission [2], in legislation introduced by Senator Kay Bailey Hutchison [3] (R–TX), and by the centrist Committee for a Responsible Federal Budget [4]. It is also part of The Heritage Foundation’s Saving the American Dream [5] plan.

Using a more accurate inflation index would save Social Security about $112 billion over the next 10 years. That is not nearly enough to fix Social Security’s massive deficits [6], but it is a good start. Doing nothing will result in 22 percent to 25 percent across-the-board benefit cuts for everyone [7] who is receiving benefits.

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URL to article: http://blog.heritage.org/2011/07/11/social-securitys-cola-needs-to-be-more-accurate/

URLs in this post:

[1] Michael Boskin: http://www.ssa.gov/history/reports/boskinrpt.html

[2] Simpson–Bowles deficit commission: http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2010.pdf

[3] Senator Kay Bailey Hutchison: http://hutchison.senate.gov/files/documents/KBH%20Defend%20and%20Save%20Social%20Security%20Act%20-%20One%20Pager%20FINAL.pdf

[4] Committee for a Responsible Federal Budget: http://crfb.org/blogs/facts-chained-cpi

[5] Saving the American Dream: http://savingthedream.org/about-the-plan/plan-details/

[6] massive deficits: http://www.heritage.org/Research/Reports/2011/05/Social-Security-2011-Trustees-Report-Shows-Permanent-Deficits

[7] 22 percent to 25 percent across-the-board benefit cuts for everyone: http://www.heritage.org/Research/Reports/2010/09/Guaranteed-22-Percent-Benefit-Cuts-If-Social-Security-Is-Taken-off-the-Table

[8] Image: http://www.heritage.org/budgetchartbook/entitlements-historical-tax-levels

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