Usually, it’s academics and economists you hear debating how to gauge the cost of living, but that’s changed since the idea of using the “chained” Consumer Price Index (CPI) for adjusting Social Security payments was proposed. The CPI deals with how the prices of necessities like food change. That formula is how food stamps, Social Security payments and veterans’ benefits are adjusted to keep up with the cost of living. Here’s how that could affect your income.
How Is the Chained CPI Different from the Present CPI?
The chained CPI formula would reduce cost-of-living adjustments compared with the CPI formula that’s currently used. The Obama administration estimates a chained CPI would reduce Social Security benefits, and the federal deficit, by $230 billion during the next decade. The Congressional Budget Office estimates it would reduce the annual Cost of Living Adjustment (COLA) by about 0.25 percent each year.
How Does the Chained CPI Reduce Income?
With the way adjustments are figured now, how we substitute to juggle price increases isn’t considered. Some say a chained CPI would be an improvement because when we can’t afford something, we substitute something that’s cheaper.
Estimates indicate the chained CPI would reduce the COLA by about .3 percentage points below the present CPI. Since that’s about $3 less on every $1,000, you may be wondering why it’s so hotly debated. To understand that, you need to figure how it’s compounded over time. Remember how compounded interest grows over time for an IRA?
Let’s take the COLA for this year. That’s 1.7 percent. That means a monthly Social Security check of $1,250 last year, is $1,271.25 this year with the current adjustment formula. If we were using the chained CPI, you would have $1,267.50 a month this year. That’s $3.75 less per month or $45 less for 2013.
With the compound effects of earning reductions after five years, a couple could have $1,230 less in income. The Obama administration has proposed a boost in benefits to older people who would be hardest hit by the chained CPI accumulation over time.
The longest living also have to deal with cumulative increases in the cost of health care, though. The Labor Department measures this as the CPI-E (for elderly people). Since 1982, that grew faster than earnings as adjusted using either the present CPI or the chained CPI.
Many have argued that the previous way of calculating the CPA resulted in overpayments. This is important to consider, since the financial health of the entire social security system is in serious danger. Personally, I’m ok with this change – what do you think?