Planning for Life

An Alternative to the Chained-CPI Social Security Proposal

Posted by Harry S. Margolis on April 22, 2013

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By Harry S. Margolis

To the dismay of many in his own party, President Obama has proposed changing the inflation formula for Social Security cost-of-living adjustments (COLAs) in a way that reduces annual increases.

The federal government uses changes in the Consumer Price Index (CPI) to adjust monthly Social Security benefits each year.The CPI is supposed to reflect the cost of purchasing typical items, such as food, clothing and transportation. Some have argued that the COLAs are too small because Social Security beneficiaries pay more of their income for health care than younger Americans, and health care costs consistently increase faster than other living expenses.

Others argue that the CPI is too high because it doesn't provide for the substitution of lower cost items when prices increase. The classic example is that when the price of beef goes up, consumers switch to less expensive chicken, so their living expenses don't really increase as much as prices do. The so-called "chained CPI" takes such substitutions into account.

President Obama in his 2014 budget has proposed switching to the chained-CPI to reduce long-term Social Security costs. The problem with this proposal is that it will hit low-income seniors who depend on Social Security to get by much more thah higher-income seniors who have other sources of income.

According to The AARP, the switch to the chained CPI would reduce COLAs by about .3 percent a year. This may not seem like much, except that it is compounded each year. Last year, the COLA was 1.7%, so someone receiving $1,250 in monthly Social Security saw a $21.25 increase. Under the chained CPI the same beneficiary would have had an increase of $17.50 a month, losing just $45 for the year. This is not much, by year two the lost benefits total $91, and they keep increasing. Ultimately, lower-income beneficiaries will face even harder choices than they do today between paying for food, medicine and heat -- the decisions becoming tougher as they get older and more feeble.

To add to the objections of many Democrats, switching to the chained CPI is not even necessary to save Social Security and does nothing to address the bigger challenge of bringing projected Medicare costs under control. Many other steps can be taken to bring future Social Security receipts and payments into balance, including raising the level of income on which Social Security tax is paid from the current $113,700 to a higher level, or eliminating the cap altogether. (Click here to read a debate on this issue on The New York Times website.)

I've long proposed more progressive alternative, which is to keep the current CPI formula but to cap the COLA, perhaps at $25 a month, or $300 a year. Since those receiving lower Social Security benefits receive smaller annual COLAs, they would be less likely to be affected by a COLA cap. Those with higher Social Security benefits generally had higher income during the working careers and have more savings and other sources of income.  They can better bear a COLA reduction.

In the example provided by The AARP, with a 1.7% COLA, the Social Security beneficiary receiving monthly benefits of $1,250 would not be affected by a $25-a-month annual cap on inflation adjustments. However, a beneficiary receiving $2,500 in benefits would receive the $25-a-month cap instead of $42.50 under the current calculation or $35 under the chained CPI formula. While this clearly would have a significant effect on higher-income taxpayers, it would permit Social Security to continue its function of keeping seniors out of poverty.

Topics: social security, COLA

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