Friday, October 17, 2008

New paper: “The Impact of Inflation on Social Security Benefits”

The Center for Retirement Research at Boston College released a new issue brief by Center director Alicia Munnell and research associate Dan Muldoon, entitled "The Impact of Inflation on Social Security Benefits," well-timed based on yesterday's announcement of a 5.8 percent annual Cost of Living Adjustment for benefits.

Today, the Social Security Administration announced that benefits payable in December 2008 would be increased 5.8 percent beginning January 1, 2009.  This cost-of-living-adjustment (COLA) – the largest in 26 years – is an important reminder that keeping pace with inflation is one of the attributes that makes Social Security benefits such a unique source of income.  (The other is that the payments continue for life.)  Higher inflation raises two other issues, however, that diminish the impact of the COLA.  The first issue pertains to Medicare Part B premiums, which are deducted automatically from Social Security benefits.  To the extent that premium costs rise faster than the COLA, the net benefit will not keep pace with inflation.  Historically, premiums have gone up much faster than the COLA, although this year is an exception as premiums for 2009 will be unchanged from their current level.  The second issue pertains to taxation under the personal income tax.  Because the thresholds ($25,000 for single taxpayers and $32,000 for joint returns) above which taxes are levied are not adjusted for wage growth or even for inflation, rising benefit levels mean that taxation reaches further and further down the income distribution.

Click here to read the whole brief.


Paul Lawin said...

I’ll apologize in advance for being excessively techy, but at first glance the statement “To the extent that premium costs rise faster than the COLA, the net benefit will not keep pace with inflation” doesn’t seem true.

The CPI-W is the average price of a market basket of goods. If one component rises more than the average, then it’s a certainty that the average of all the others rises less than the grand total average.

Medicare Part B premiums reflect medical care prices. If medical prices are going up faster than the overall CPI-W, then the total of all non-medical prices has to go up more slowly. If the weights were perfect, the “net benefit” would exactly keep pace with the inflation in the rest of the market basket.

I know the weights aren’t perfect. Munnell/Muldoon have a discussion of CPI-W vs. CPI-E in the box. That’s useful.

But the bigger problem with weights is that medical insurance premiums reflect both prices and usage. Medicare Part B premiums have gone up 105% in the last 9 years, while the CPI-W medical component has gone up 45%. The difference is probably usage (where I’m including new services as “increased usage”). All consumers are impacted by this - the Kaiser Foundation says that the average employee cost for group family medical went up 117% in the same time period.

The loss in “net” purchasing power that M/M calculate is not the result of higher medical care prices but rather of increased medical care usage. It’s a confusing fact that our CPI system measures the costs of specific medical services, but consumers view their cost of medical care to be insurance premiums. So which is the “true measure” of “inflation” that should be used for COLA adjustments?

I think a discussion of how changes in medical care usage impact both retirees and workers would be interesting, but M/M simply reference “inflation” without mentioning the price-vs-usage issue.

Andrew G. Biggs said...

You raise a good point. Here's another way to think about it: in several papers Alicia Munnell has argued that we should think about Social Security replacement rates net of Medicare premiums; hence, if premiums rise faster than benefits the replacement rates have fallen.

But this treats Medicare as a tax rather than a consumption good. The fact is that premiums cover only around 20% of total Medicare spending, most of which is driven by rising consumption rather than true price inflation. If premiums rise, that implies that per-person spending has risen by around five times that amount.

Now, if seniors derived no benefit from Medicare spending -- if it were just a waste of money -- then I guess we could treat rising premiums as a "tax" on their benefits. But it's hard to believe this is the case: even if increased spending it's efficient at the margin, the net gain to beneficiaries is a lot higher than zero.

In short, I think the line of argument in the paper is basically miscast, but that's just my view.

Paul Lawin said...


Thanks for the response. I can see that you've gone down this road before - your reasoning makes a lot of sense.

John J said...

I think each of you are incorrect. According to your logic the price of an item increases as more of it is used which is counter to economic theory. The more of an item is used the lower the price because the cost becomes lower as efficiencies of production are implemented. Unfortunately in the present medical environment we are in your backward logic seems true. However, any theory must account for the reasons costs are escalating. Some reasons include plain inefficiencies, excessive administrative costs, inflated prices, poor management, inappropriate care, waste and fraud. The US spends $480 billion in excess medical spending as opposed to our Western European friends. Additionally, most employers cite that medical costs are higher because 36% of their employees underuse preventative care measures. So the cost usage theory you use must account for these factors. Also, in the case of retires the out of pocket medical costs consume a larger portion of their income because there is less income. It's estimated that at 85 years old the average out of pocket medical expense is 30% of income. Therefore it seems the insurance premium paid by the retire is not related to the benefit because of these factors. The premium is not determined just by usage. We do not know the benefit because the true cost cannot be determined at this time. It seems the conclusion in M/M is correct in that the rising medical premiums reduce the net benefit available for non-health expenditures.