What you need to know about Social Security’s 2023 Cost-of-Living Adjustment

The Social Security Administration is expected to announce a substantial cost-of-living adjustment (COLA) for Social Security and Supplemental Security Income (SSI) benefits on Thursday, October 13. This adjustment is one of the highest COLAs in many years. (The highest COLA in Social Security history was in 1980 at 14.3 percent. It was part of a three-year stretch of record-setting COLAS – 9.9 percent in 1979 and 11.2 percent in 1981. There were no COLAs in 2009 and 2010. After five years of COLAs under 2 percent, the 2022 COLA was 5.9 percent.) The adjustments will be made effective for Social Security beneficiaries in January 2023 benefit payments.

The 2023 COLA represents a catch-up measure to help compensate beneficiaries for high levels of inflation that they have already experienced. Given that the adjustment is applied universally, it will not reflect geographical differences in real prices and living costs, thus it will undercompensate some beneficiaries, and overcompensate others.

Social Security’s annual COLA is intended to protect the purchasing power of benefits against erosion by price inflation. It is vital to beneficiaries – 52.5 million older individuals and another 17.9 million younger people – that benefits keep up with the cost of living, as other sources of income typically decline with age. As individuals grow older, their pensions are eroded by inflation, employment options end, spouses cope with widowhood, and savings are often depleted leaving seniors to rely even more on Social Security. This is especially of concern to people with disabilities, who rely greatly on Social Security Disability Insurance benefits and/or SSI.

The following is a clarification of how the COLA is calculated, why the current method is used, and an identification of possible changes to the method.

How is the COLA calculated?

The COLA was added by Congress to Social Security in 1972 to ensure that benefits would automatically be adjusted to reflect changes in the cost of living to defray delays caused by ad hoc, politicized, and often belated Congressional action. The automatic COLA first took effect in 1975. At the time Congress enacted annual automatic Social Security COLAs, the Bureau of Labor Statistics (BLS) produced only one CPI to measure inflation experienced by urban wage earners and clerical workers.

Social Security COLAs are calculated based on the percentage change in consumer prices, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), from the third quarter of one year to the same quarter the following year. Retirees are not part of those sampled in producing the CPI-W.

Why is this method used?

In 1978, BLS expanded the CPI to cover all urban residents (about 88 percent of the population, including most retirees) and named it the Consumer Price Index for All Urban Consumers (CPI-U). The CPI-U is used to index personal income tax brackets and poverty thresholds but is not used to determine Social Security COLAs. In 1988, BLS launched a third, experimental index, the Consumer Price Index for Americans 62 years of age and older (CPI-E), which reflects the spending patterns of persons aged 62 and older.

These indexes measure changes over time in the price of a basket of goods and services purchased by their respective populations. In 1999, BLS slowed the growth of all the indexes by accounting for consumer substitution among similar items and began tracking a “chained” version of the CPI-U. A chained index reflects the extent to which consumers make changes in their purchasing patterns across dissimilar categories of items – such as spending more on fuel and less on food – in response to relative price changes. The “chained” CPI-U has usually risen more slowly per year than the CPI-W.

The original CPI was renamed the CPI-W. It remains the only method used to calculate Social Security COLAs, since other methods have not been adopted by Congress.

What changes to the method might be considered?

Some have called for BLS to develop an improved CPI-E for the elderly for the purpose of adjusting Social Security benefits. They argue that current indexes do not accurately measure the actual living costs of the elderly, including their health care costs, and point to alternative measures of inflation that specifically consider the inflation experienced by the elderly.

One metric to consider is the Elder Index which seeks to measure the income that older adults need to live independently. This index, developed by the University of Massachusetts and adopted by the National Council on Aging examines the economic needs of older people for housing, health care, transportation, food, and other essentials.

A revised CPI-E might come closer to reflecting the actual cost of living of older persons, who make up about two-thirds of all Social Security beneficiaries. Living costs for older persons usually rise faster than for other households, because medical care usage increases with age, and health care prices are growing faster than prices for other goods and services.  While the experimental CPI-E reflects the spending of households age 62 and older, it is based on a relatively small sample and is not based on a dedicated survey of the spending patterns of older households. To obtain more accurate estimates, BLS would need to survey a larger sample of households and survey shopping outlets specifically used by older consumers.

Conclusion

Social Security makes up an ever-greater share of income for most as they age. While Social Security’s automatic COLAs are a valuable feature of the system, they might function better if they were based on an index that more accurately measured the cost of living experienced by older Americans. This is of growing concern as the rate of poverty among older Americans has increased to 10.3 percent in 2021 from 8.9 percent in 2020.

For more information on Social Security’s cost-of-living adjustment, please contact William Arnone, CEO, at warnone@nasi.org.