Tuesday, October 13, 2009

New paper: “A diet COLA for Social Security? Not really.”

Heading into SSA's expected announcement on Thursday of the 2010 Cost of Living Adjustment, I have a new paper in AEI's Retirement Policy Outlook series titled "A diet COLA for Social Security? Not really" that examines whether current beneficiaries are truly being hurt by not receiving COLAs over the next several years. The answer, in my view, is pretty clearly no. The 2009 COLA paid in January of this year inadvertently increased the real purchasing power of Social Security benefits by around 5 percent. As a result, Social Security will not pay COLAs until prices rise by around 5 percent, bringing the real value of benefits back to their intended level. In the meantime, however, real benefit levels will be above last year's, increasing the typical senior's buying power by around $1,000 before COLAs resume.

I've inserted a chart below showing the CPI-W over the last year or so. In mid-2008 there was a rapid increase in prices, such that a 5.8 percent COLA was granted in October of 2008. By the time the COLA began being paid in January of 2009, however, prices had dropped back below their 2008 levels. Once the CPI rises back to it's level at the 3rd quarter of 2008 – a value of around 216 – COLAs will again start being paid.

While current retirees aren't being hurt, as I argued here, new beneficiaries – principally people aged 62 today, but also including new applicants for disability and survivors benefits – will be hurt, as they will be penalized by not receiving COLAs over the next two years but didn't receive the large 5.8 percent 2009 COLA. These folks deserve some help.


Pops said...

Did you include the 4.54% increase in national average wage index between 2006 and 2007? A person born in 1946 with an AIME of $4000 would have an AIME of 4181.53 (for the same earnings in the same years) if born in 1947 (one born on Dec 30, 1946, the other on Jan 2, 1947). The corresponding initial PIA's are 1692.3 and 1769.4. The person born in 1946, after the COLA of 2009 will have a PIA of 1790.4, which is only 1.19% larger than the PIA of the person born in 1947.

Andrew G. Biggs said...

This is a good comment which raises some important issues. Because average earnings are "indexed" to wage growth, this implies that an increase in average wages of x percent as of age 60 will tend to increase all average wages by the same percentage. I've heard some feedback from folks within SSA that the 4.5% increase in wage growth from 2006-2007, which have occurred when the 1947 birth cohort was age 60, would almost make up for benefit reductions of around 5% due to not receiving COLAs for two years.

As I see it, while differing wage growth as of age 60 (and other ages) can produce little 'nothces', we don't want to ignore that Social Security is supposed to be wage indexed system, such that average benefits rise from cohort to cohort with wages. So what matters here isn't the gross rate of wage growth as of age 60 for the 1947 cohort -- 4.5% -- but the wedge between that rate of wage growth and the typical levels for other cohorts. Over the last 20 years the typical level was around 4% so the wedge was only around 0.5%.

Put another way, what matters here isn't how the 1947 birth cohort's benefits compare to those of the 1946 cohort; they're supposed to be different. What I'm looking at is the level of benefits for the 1947 cohort given the unusual inflationary spike we experienced versus a more normal, smoother outcome.

This answer is probably incomplete but I'm going to be doing so more work in this area and will try to flesh things out a bit. Thanks.