COLA's, Congress, and Change

October 29, 2002

Martin Crutsinger of the Associated Press writes, "Social Security recipients will get a 1.4 percent cost-of-living increase in their monthly checks next year, the smallest in four years." An extra thirteen dollars a month for the average retiree beginning in January, the increase "is down from this year's boost of 2.6 percent. In 2001, benefit checks went up by an even larger 3.5 percent, the biggest cost-of-living rise in nine years." The smaller increase reflects "the dampening effect last year's recession and this year's uncertain recovery has had on the ability of businesses to raise prices." Though Social Security Commissioner Jo Anne B. Barnhart commented "that lower inflation is good news for people living on a fixed income."

The new benefit increase will mean $895 for the average individual recipient up from $882, and $1,463 for the average couple receiving benefits up from $1483. However, "Social Security also announced that for working Americans, the maximum annual earnings subject to Social Security taxes next year will rise to $87,000 from $84,000 currently. This change will affect about 9.7 million of the 155 million workers paying Social Security taxes."

The midterm election campaigns have seen "Democratic congressional candidates [attack] their Republican opponents over the issue of how best to bolster the program's finances to cover the retirement of baby boomers." Many Republicans have advocated allowing workers to invest a portion of their Social Security tax in personal accounts in order to make the system sustainable over the long term. But "Democrats have used the stock market's steep plunge to attack the idea of privatizing any part of Social Security and have run campaign ads against Republicans accusing them of pushing risky schemes that will put retiree's Social Security benefits at risk."

"Many analysts believe the bitter campaign debate and the government's rapidly worsening budget outlook will make it far harder in the next Congress to come up with a solution to the Social Security problem." The Cato Institute's Michael Tanner "said the outcome of the Nov. 5 elections will play a big role in determining whether the idea can win approval in the next Congress."

These annual cost of living adjustments (or COLAs) receive great publicity, but are also subject to a good deal of misunderstanding. Newspaper editorials and certain seniors groups have decried this year's 1.4 percent increase as "stingy" compared to increases in past years. Others have argued that a slowing economy has somehow limited the increases that Social Security can offer. Neither complaint is true.

Annual COLAs are designed for one purpose: to maintain the purchasing power of Social Security benefits from year to year. If inflation is high in a given year, a large increase will follow so that the buying power of benefits remains the same. If inflation is low, the benefit increase will be smaller. But in terms of the actual goods and services that seniors can purchase with their benefits, the COLA is not designed to increase purchasing power, but simply maintain it at the same level. Hence, the size of the annual COLA makes no difference to the standard of living that Social Security benefits can provide.

Moreover, the high inflation rates that would cause large cost of living increases would also eat away at the fixed- income investments that most seniors hold. For example, a senior holding a bond that pays 6 percent annually receives a 5 percent real return if inflation is 1 percent. If inflation is 3 percent, however, the real return from that same bonds falls to just 3 percent. Hence, larger COLAs usually signal bad news for seniors, not good news.

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