Tuesday, May 5, 2009

A Raise for Social Security Recipients

Cross posted from the new American Enterprise Institute blog

Robert Pear writes in the New York Times "Social Security Benefits Not Expected to Rise in '10" but draws an almost 180 degrees mistaken conclusion from it all. Pear and others are reporting alarm that no Social Security Cost of Living Adjustment (COLA) will be paid this year. In fact, the lack of a COLA implies a real increase in the buying power of Social Security benefits. Unfortunately, no one seems to know that.

Ordinarily, each January Social Security benefits for retirees, survivors, and the disabled are increased through a COLA to match rises in the Consumer Price Index (more precisely, a sub-measure called the Consumer Price Index for Urban Wage Earners and Clerical Workers, also called the CPI-W).

However, the Congressional Budget Office has projected that for 2010, 2011, and 2012 no COLAs will be payable. The reason is a year of high inflation—this past January's COLA was 5.8 percent, the highest since 1981—reflecting the run-up in energy prices last year. However, since that time energy prices and prices for many other goods have dropped. The CBO projects that the overall Consumer Price Index won't reach its 2009 level until 2012, meaning that a new COLA won't be payable until 2013.

Pear's article, and public reaction to COLAs in general, reflects a mistaken view that inflation adjustments for Social Security benefits are a "raise"—the higher the COLA, the happier people seem to be. A year with no COLA is treated as a year without Santa Claus. In Pear's article, for instance, AARP's David Certner says, "Most seniors have never been through a year in which there was no Social Security COLA." Of course, most seniors have never been through a year without inflation either. If you don't have the latter, you don't need the former.

But Pear's article misses an even larger point: Social Security COLAs can never be negative. That is, even if prices fall, Social Security benefits can never be reduced to match them. Logically this is what true inflation adjustment would do—COLAs are merely intended to match the change in prices to keep purchasing power the same, not to alter the real value of Social Security benefits. But people are extremely resistant to reductions in nominal income. Realizing that, Congress wrote the Social Security Act so that even if prices fall, benefits will remain the same.

When prices fall but Social Security benefits remain the same, that means the real purchasing power of benefits has risen—in other words, it's a raise. When people are complaining about not getting a COLA, they're actually getting a real increase in their benefits. In other years when the COLA is positive and they think they're getting a raise, they're actually not.


Jim Glass said...

"Money illusion" in action.

Bruce Webb said...

Excellent point Andrew. Dean and I have been trying to explain this point to a group we belong to. The consensus is that Congress will be forced to step in. But this I think demonstrates an unawareness of the actual process.

Some guy on Dean's blog comments was raging about how the Congressional Democrats screwed over workers after taking control. I had to explain that this is an automatic process.

Which doesn't mean Congress won't do the irrational thing and grant a pseudo-COLA anyway, but Pears didn't do anybody on either side a favor with that piece.