03/07/2012 12:00 pm ET Updated May 07, 2012

Proposed Social Security Chained COLA Not Ready for Prime Time

COLA's Goal -- To Preserve Benefit Purchasing Power As Prices Rise

In the 1960s, seniors' poverty rate exceeded those of younger age groups. That became a great concern leading to rapid enactment of a series of stand-alone Social Security retiree benefit increases. To some, the boosts seemed impelled by the presidential ambitions of the chair of the House Committee on Ways and Means. Advocates of benefit improvements joined forces with advocates of restricting them to objective criteria, that is, increases in the Consumer Price Index (CPI).The committee's Republican ranking member proposed annual benefit adjustments when the cost of living, as measured by the CPI, rose. That Cost-of-Living-Adjustment (COLA) prescription, which was enacted, met two objectives: offsetting the erosion of benefit purchasing power by inflation and restraint in doing so.

The Questionable Claim That COLA Overstates Inflation; COLA Lags Behind Inflation

Proponents of chained seek to justify that new method with the claim that COLA currently overstates inflation because it does not reflect the substitutions of lower-priced goods made by benefit recipients. But, it is questionable that, in the real world, many beneficiaries make such substitutions.

Chained COLA Assumes Substitutions Which Are Often Difficult or Impossible To Make and That Consumers Outwit Marketing Specialists

How many of us are such canny shoppers? How many of us check the unit prices and compare them to possible substitutes? If we do so sometimes, how often? And do we do so when it requires inspecting the lower shelves? How many such efforts are forestalled by arthritis or defeated by bi-focals? And if consumers can read the prices, how many can translate one set of measures, say fluid ounces, into another set, such as pints or quarts? How many of us can tell whether we would get a bargain or get stung?

Under the Present Structure COLA Chronically Lags Behind Prices

COLA becomes operative when prices measured in the Fall exceed the corresponding prices in the preceding Fall. That percentage is applied to each beneficiary's benefit for the next year starting in January. In consequence, Social Security COLA does not offset price increases when they occur. And it does not offset prices increases that take place during the year it is operative. At best, Social Security COLA adjusts benefits to price levels that existed before it goes into effect. And during the year it applies, when prices increase, as they so often do, benefit purchasing power declines. So, COLA overstates inflation only when the process produces a boost in benefits, the increase goes into operation and prices decline thereafter.

How Chaining Would Reduce the Value of COLA

The Social Security actuaries calculate that a chained COLA would be .03 percent lower each year than the benefits projected under existing arrangements. This may seem miniscule for those with current job earnings and multiple sources of income. But benefits now are extremely modest - on average, about $1100 a month. Further, typically women qualify for lower benefits because of past sex discrimination in employment and its persistence in some areas, their smaller representation in high-paying jobs and their more frequent withdrawal from the labor market to tend other family members.

Moreover, that .03 percent gets larger every year. After 10 years of COLA, benefit reductions would cumulate to more than .3 percent. These numbers may seem small to those with current earnings. But for most retirees, small reductions can be painful. Meanwhile other sources of income usually shrink and the ability of beneficiaries to provide services to themselves diminishes.

Current CPI Gives Too Little Weight to Typically Higher Beneficiary Health Costs

Current COLA is based on the entire working population with a larger portion of young and non-disabled people than the more costly older and disabled patients eligible for COLA. The different demographic patterns result in giving insufficient weight to the typically higher health care costs borne by SS beneficiaries. That burden tends to grow with age.

With Other Income Ravaged by Recession, Social Security More Vital Than Ever

Income from non-Social Security usually declines with age. Moreover, non-Social Security resources have diminished: defined benefit pensions have been vanishing, IRA and 401(k) valuations plummeted in the Great Recession, demonstrating their unreliability to provide for lost income; and for millions, the value of their most usual form of savings, a home, has declined. And, worst of all, jobs are harder to get and keep, new employment opportunities have shrunk and job earnings for most people have been flat for years.

Calculating Chained COLA Data Takes Two Years - Thus It May Prove Unworkable, At the Very Least More Costly To Calculate and Apply

It is hard to see how a chained cola, with twice the lag of current CPI/COLA arrangements, could supply protection against the degradation of Social Security benefit purchasing power. To overcome that drawback would require adding some substitute amount to bridge periods when prices rise, thereafter recalculating the proper supplement for actual understatement or overstatement of inflation when the relevant numbers become known. Constructing such a sequence - initial benefit adjustment on an estimated basis subject to readjustment when actual price numbers materialize - would be difficult, if doable at all. It would probably require simultaneously conducting two calculating sequences every year - to generate the impending year's COLA and to determine the annual adjustments in benefits paid in the current year. In the next succeeding year, the same double calculation procedure would be followed. That would produce annual leap frogging chained COLAs. If some plausible procedure to do this were devised, each year's determination would have to take place in two stages - an initial determination followed by an adjustment to the chained COLA every year. Just how to weave the adjustment into each successive year is not immediately apparent.

These sequences would increase the non-benefit costs of COLA. Whether there would be a net savings is not knowable, even preliminarily, until the sequence for paying and adjustment is worked out - if it can be. For certain, each year's COLA would take more processing of data. The need to have at least two separate successive sequences of COLA determinations would increase non-benefit (administrative) costs.

Until the necessary procedures are designed, tested, and proven feasible, chained COLA will not be ready for prime time. Even then, it would reduce benefits and impose harm without adequate justification.