The Social Security Administration today announced that it will pay a Cost of Living Adjustment of 1.5 percent to benefits beginning in January. You don’t have to look far in the next few days to find comments that this COLA is too low, that, as the AARP states, “it will quickly be consumed by the rising costs of basic needs like food, utilities and health care.” In particular, many argue that COLAs, which are calculated based on changes in the prices of goods purchased by the general population, don’t reflect rising prices for goods particularly used by seniors, such as health care. Many argue for basing COLAs on the experimental CPI-E, which tracks prices based on the buying habits of the over-65 population.
On the other hand, most economists – and, it seems, the Obama administration – believe that current COLAs overstate inflation. They favor using the so-called “chained CPI” that accounts for how purchasing habits change in response to changing prices. This will usually produce lower inflation and, thus, a lower COLA.
There are better alternatives. For one, a chain-weighted version of the CPI-E, which accounts both for the buying habits of the elderly as well as how their purchases change when prices change.
Alternately, I’ve proposed a COLA that deliberately raises benefits by more than the rate of inflation, coupled with a lower initial benefit to keep total costs constant. A higher COLA would reduce poverty in truly old age, where it’s most prevalent, and the lower initial benefit would encourage near-retirees to work a little longer.
So the issue isn't simply technical; it’s a policy question about what you want Social Security to do.