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The COLA wars

Outrage about the absence this year of a cost-of-living adjustment for Social Security recipients is based on ignorance of the system.

May 21, 2009|Andrew G. Biggs | Andrew G. Biggs is a resident scholar at the American Enterprise Institute and was previously the principal deputy commissioner of the Social Security Administration.

There's a cola war going on, but it has nothing to do with Coke versus Pepsi.

It began earlier this month when the Congressional Budget Office projected that for the first time in three decades, there would be no cost-of-living adjustment -- or COLA -- for Social Security recipients in 2010, 2011 and 2012.

These adjustments are designed to keep elderly Social Security recipients from losing purchasing power as prices rise, so it's not surprising that the initial reaction was one of concern.

"The absence of a cost-of-living adjustment ... will be a shock to older Americans already hit by plummeting home values, investment losses and rising health costs," wrote the New York Times.

Senior groups were predictably up in arms. An AARP spokesman moaned that "most seniors have never been through a year in which there was no Social Security COLA." Some liberal bloggers accused the Obama administration of betraying seniors. And there's already talk of legislation to address this perceived inequity.

But the outrage is unwarranted. It's true that most seniors have never faced a year without a COLA, but that's only because they've never experienced a year without inflation, which is what the Congressional Budget Office says is what's happening now.

The COLA is not supposed to be a "raise" in Social Security benefits, even if seniors often see it that way. Rather, when the consumer price index, or CPI, rises in a given year, Social Security benefits are adjusted upward to match that rise in inflation. If done accurately, the purchasing power of Social Security benefits before and after a COLA will be precisely the same.

Under law, Social Security benefits are not allowed to outpace inflation except in one special case: when prices fall. That's because Congress, leery of the political consequences of cutting anyone's benefit check, structured the Social Security Act so that when inflation is negative, COLAs don't go down, but they remain at zero. And when inflation is negative and the COLA is at zero, purchasing power is actually going up. If retirees understood that, they'd hope to never receive another COLA.

That's what's happening now. Rising energy prices drove the CPI sharply upward last year, and as a result, seniors received a large 5.8% COLA to compensate in 2009. Since then, however, almost that entire CPI increase was lost as energy prices dropped, and the CPI is projected to remain below 2008 levels through 2012.

In a world in which policy trumped politics, falling prices would lead to negative COLAs just as rising prices lead to positive COLAs. But that's not the world we live in.

And there's another twist: Congress also has ruled that increases in Medicare Part B premiums, which are automatically deducted from retirees' Social Security benefits, cannot result in benefits declining from year to year. If there is no COLA this year, this implies that Medicare Part B premiums cannot increase either, despite the fact that by law these premiums must finance 25% of total Part B costs.

Legitimate questions remain regarding Social Security COLAs. Many economists think that the CPI overstates inflation; if true, that means that existing COLAs are too high. Seniors groups, on the other hand, think that the CPI, based on working-age Americans' spending habits, doesn't adequately address seniors' heavy healthcare spending. By that way of thinking, the CPI may understate price increases for seniors. But these matters are entirely separate from the COLA dispute currently underway.

Groups such as the AARP are surely aware that a zero COLA actually means higher real benefits and lower Medicare Part B premiums. But the AARP nevertheless warns that seniors "feel like they are falling behind." That's irresponsible -- especially from such a powerful lobbying organization with the ability to change the debate in Washington. If the AARP seeks to be something more than a mere "union for retirees," it must use its considerable influence more carefully.

Inflation protection for retirees is important, but it's just as important not to increase Social Security benefits and reduce Medicare premiums when it's not necessary -- and when these programs are, as the federal government regularly informs us, vastly underfunded.

If Congress were to succumb to political pressure and provide a COLA when none is needed, it would only compound the problem.

One part of the solution is to make sure retirees understand how inflation and COLAs work. A second part is for Congress to say no to powerful voting blocs when they're out of line.

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