The numbers don’t lie: Social security is the most important social program of the United States. According to the Center on Budget and Policy Priorities, Social Security is responsible for lifting nearly 22.5 million people out of poverty each year. More importantly, it reduced the poverty rate among the elderly to 9% from an estimated 38% if Social Security did not exist.
Polls have shown that the vast majority of working Americans expect to rely on Social Security income to some degree after retirement. A national Gallup poll found that a combined 84% of non-retirees expect Social Security to be a “major” or “minor” source of income in their golden years.
Because of the importance of Social Security to the financial well-being of tens of millions of Americans, there is perhaps no more important message than the annual cost-of-living adjustment (COLA).
Understanding the Social Security Cost of Living Adjustment
The simplest way to think about COLAs is that the “raise” is passed on to program beneficiaries most years. But as you’ll notice when I put “raise” in quotes, it’s not the usual raise you get from your employer. A COLA is an increase that is designed solely to help recipients keep up with the inflation they are struggling with. In other words, when the prices of goods and services rise, Social Security benefits should ideally increase so that beneficiaries can purchase the same amount of goods and services.
Since 1975, the Consumer Price Index for Urban Wage Workers and Clerical Workers (CPI-W) (thank goodness for acronyms!) has been the inflationary chain of Social Security. CPI-W has eight main categories of expenditure and many sub-categories, each with their respective percentage weights. These weighting factors allow us to arrive at a single CPI-W reading that can be compared to previous months or years to determine whether inflation (rising prices) or deflation (falling prices) has occurred.
However, only CPI-W readings for the third quarter (from July to September) were used. calculate the Social Security cost of living adjustment. While the remaining nine months may be useful for determining trends, they will not affect whether beneficiaries will receive a “raise” next year.
If the average CPI-W for the third quarter of the current year is higher than the average CPI-W for the third quarter of the previous year, Social Security recipients receive a “boost.” The magnitude of the increase is the percentage increase in the CPI-W average for the 3rd quarter over the previous year, rounded to the nearest tenth of a percent.
How does an extra $192 a month sound?
In 2023, Social Security’s COLA may well be history. While it is won’t be anywhere near the biggest cost-of-living adjustments in history, this has the chance to be the largest nominal dollar increase in Social Security checks by a significant amount.
A little over two weeks ago, the Senior Citizens League (TSCL), a nonpartisan advocacy group for seniors, released a report outlining its thoughts on where the Social Security COLA could go next year. According to TSCL welfare policy analyst Mary Johnson, there is a wide range of results. If inflation cools down between July and September, the COLA could be “only” 9.8%. However, if inflation continues to rise during the summer months, Social Security’s COLA could be a staggering 11.4% in 2023. For context, the US inflation rate for June hit a four-decade high of 9.1%.
What would an 11.4% COLA look like in dollar terms for the average retiree? As of June 2022, the average monthly benefit for 47.9 million retirees was $1,669.44. Typically, this average payment increases by about $2 per month due to new retirees entering the recipient pool. Therefore, by December 2022, the average monthly benefit for retirees should be approximately $1,683.
If inflation were to heat up and the Social Security COLA hit Johnson’s high-end estimate of 11.4%, the average retiree would expect to see a $192 per month increase in their Social Security check in January 2023. That would equate to an average take home check of $1,875 in month.
Social Security beneficiaries could face a double whammy in 2023
An “increase” of $192 per month will represent the largest increase in income in nominal dollars compared to last year in the history of Social Security. To boot, the 11.4% COLA would be the second largest percentage increase since CPI-W became the program’s inflation anchor.
But despite this potentially historic increases in monthly paymentsit’s not all peaches and cream for the program’s more than 65 million recipients.
To begin with, high cost-of-living adjustments over many decades mean that beneficiaries are struggling with rapidly rising costs. There is a good chance that most or all of the 2023 “raises” recipients receive will be eaten up by increases in the cost of food, housing, health care, electricity, and a host of other cost categories. And that’s not all.
A double whammy for the program’s recipients is that the purchasing power of Social Security income has been falling for more than two decades. A TSCL report from earlier this year showed that the purchasing power of Social Security dollars has declined by 40% since 2000. An 11.4% cost of living adjustment will do little to close the gap in purchasing power that has existed for 22 years (and counting).
The reason for this persistent decline in purchasing power is that the CPI-W does not capture it well inflation faced by the elderly. The CPI-W is designed to track the spending habits of urban and blue-collar workers, most of whom are of working age and do not receive Social Security benefits. The net result is that the CPI-W reduces the weight of essential expenses for the elderly, such as shelter and health care, while placing more emphasis on less important expenses such as clothing and education.
There’s no easy solution to Social Security’s purchasing power dilemma, which means that even a historically high COLA in 2023 won’t help retirees if it doesn’t.
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