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Wednesday, January 16, 2013

Using a Different Cost-of-Living Measure for Social Security Beneficiaries: Some Policy Considerations

Christine Scott
Specialist in Social Policy

Social Security cost-of-living adjustments (COLAs) are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is a measure of inflation calculated by the Bureau of Labor Statistics (BLS). The Social Security Administration determines the Social Security COLA by using the CPI-W in a formula specified in the Social Security Act.

Recently there have been several proposals to replace the CPI-W in the COLA formula with other measures of inflation produced by the BLS. For example, the 2010 National Commission on Fiscal Responsibility and Reform (Senator Simpson and Mr. Bowles) and the Bipartisan Policy Center (Senator Domenici and Dr. Rivlin) have proposed replacing the CPI-W with the Chained CPI for All Urban Consumers (C-CPI-U) in the Social Security COLA formula. The issue has also come up during the course of budget negotiations.

Proponents of basing the COLA on the C-CPI-U argue that it would be a more accurate measure of changes in the cost of living because it better captures how consumers respond to changes in the relative prices of items. Using the C-CPI-U to compute COLAs would save money for the Social Security system, because the C-CPI-U’s methodology for capturing substitution among items tends to result in lower measured annual inflation than the CPI-W, which in turn would generally result in lower annual Social Security COLAs.

Other analysts argue for basing the Social Security COLA on the BLS’ Experimental Consumer Price Index for Americans Aged 62 and Older (CPI-E), which uses a market basket that more closely reflects the spending patterns of the elderly. The CPI-E gives a larger weight to out-ofpocket health care expenditures than BLS’ other indices. Because health care prices tend to rise more rapidly than the prices of many other items, annual inflation as measured by the CPI-E tends to be higher than with the CPI-W. As a result, COLAs computed using the CPI-E would rise more quickly than current law COLAs, and expenses to the Social Security program would also increase.

This report explains how the Social Security COLA is computed under current law and discusses some of the concerns that have been raised about the CPI-W as a true measure of the cost of living. It then provides a brief summary of alternative measures of inflation that have attracted recent attention, such as the C-CPI-U and the CPI-E. The report offers policy considerations with respect to changing the COLA calculation, including economic security among the eligible beneficiary population, the potential impact on older retirees’ benefit amounts, administrative issues related to alternative price indices, and the financial impact on Social Security of basing the COLA on alternative CPI indices. It concludes with key recent proposals to require alternative COLA computations.

Date of Report: January 10, 2013
Number of Pages: 17
Order Number: R42086
Price: $29.95

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