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The Impact of Reductions in the Social Security Cost-of-Living Adjustment (COLA)

According to the Social Security Trustees, the Social Security Trust Fund will be able to pay full benefits until 2037, and incoming payroll taxes will be sufficient to pay about 78 percent of benefits thereafter. Some are using this modest gap in long-term funding as a pretext to justify proposals for large cuts in Social Security benefits destined to reduce the federal deficit. Although most policymakers have pledged to limit the impact of Social Security changes to younger workers, one option under serious consideration would cut future benefits for all workers - including those who are already retired. This proposal would reduce future Social Security Cost-of-Living Adjustments.

Why the COLA is Important

Social Security is one of the few retirement programs that provide an automatic annual cost-of-living adjustment (COLA) to beneficiaries. The annual COLA is intended to ensure that Social Security benefits for retirees, survivors and the disabled maintain their purchasing power by keeping pace with inflation. To achieve this goal, it is important that the COLA be based on an index that accurately reflects the purchasing patterns of beneficiaries. In that regard, the current COLA misses the mark.

While some economists have argued that COLAs should be reduced, others believe that the current calculation for determining the COLA understates inflation experienced by older people because it does not adequately consider rising medical costs. This is especially harmful to the elderly because so much of their income is spent on medical expenses, which are increasing at a faster pace than general inflation. About 40 percent of today's Social Security benefit, on average, is spent on health care out-of-pocket costs, even with Medicare, and this percentage is expected to continue rising over time.

This continuing increase in health care costs will leave beneficiaries with a steadily declining standard of living as less of their income will be available to pay non-health related expenses. Proposals to reduce the COLA would be especially damaging to low-income workers who depend on Social Security for most of their income, and to women who have a longer life expectancy in retirement.

Currently, Social Security beneficiaries receive annual cost-of-living adjustments (COLAs) based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, the CPI-W. In October of each year, the Social Security Administration (SSA) announces the percentage by which Social Security checks will increase in the following year. For most of the last decade, the Social Security COLA has been in the two to three percent range.

The current recession and last years' extremely high oil prices resulted in 2010 being the first year with a zero COLA since the automatic increases were established by the Congress in 1975. The lingering effects of the recession are expected to produce a second zero COLA year in 2011, followed by unusually low COLAs in subsequent years.

Some Propose to Arbitrarily Cut the COLA

Even though the current COLA fails to consider fully the effect of rising health care costs on the elderly, and even though the amount of the COLA adjustment in recent years has been negligible, some propose even further reductions. These usually take the form of arbitrary or ad hoc reductions in the amount of the COLA passed on to beneficiaries. Often referred to as "diet-COLAs", these proposals are usually advocated, not because they are good for Social Security, or the people who depend on the program, but rather because they would reduce the cost of the program and help balance the budget.

Why a COLA Cut would be Harmful

  • The current COLA calculation does not reflect the actual inflation experienced by the elderly. Older Americans spend a greater share of their income on health care costs than other Americans and those costs are rising faster than general inflation.
  • If the COLA is too low compared to the real cost of living, the people who will be most affected are those who live the longest. That is because the COLA compounds over time like interest on your savings. Similarly, a cut in the COLA compounds over time. If the COLA is lower than inflation, an elderly person will get further and further behind in his or her purchasing power over time.

As a result, a change in the COLA formula has the largest impact on the oldest of the old. For example, it has been estimated that reducing a 3 percent COLA by one percentage point each year would erode benefits by more than 20 percent for an 85-year old beneficiary who had retired at age 65.

Most of the oldest-old are women because they live longer, on average, than men. By age 85, seventy-one percent of Social Security recipients are women. Thus, a COLA reduction would disproportionately affect older women who are among the poorest people in the country.

Conclusion

Despite the impression left by some, the average Social Security retirement benefit today is modest - only $13,800 per year overall with an average of only $11,800 per year for women. Reductions in the Cost-of-Living Adjustment will result in real cuts in benefit levels over time for both current retirees and for those retiring in the future , and will have the harshest impacts on our most vulnerable seniors. Cutting Social Security benefits, no matter how it is accomplished, should not be the first or even the last place Congress looks for budget savings.

Government Relations and Policy, August 2010



   

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