Monthly Archives: December 2012

Social Security and the Fiscal Cliff

As negotiations have continued to avert the ‘fiscal cliff”, there have been attempts to balance increases in taxes with reductions in projected entitlement payments. Press reports indicate that the Obama has offered to change the way that Social Security cost-of-living adjustments (COLAs) will be measured. The projected savings from using an alternative measure of inflation are projected to save the government substantial outlays over the coming decades.
AARP and other organizations have objected strongly to these changes since they could bring down benefits that seniors will receive in their retirement. These organizations are also correct in arguing that Social Security’s long-term financial problems can be fixed with less radical changes.
An important consideration in evaluating these arguments is whether the changes that are being proposed are fair to seniors who have paid their Social Security taxes and have been promised reasonable benefits from Social Security when they retire.
Economists generally agree that the present cost-of-living measure that is used by the government in adjusting Social Security benefits and other government programs overstates the actual changes in the cost-of-living. They have adopted a different measure called a chained-index which better represents the changes in the cost-of-living. This chained-index is what Obama has now agreed to use for calculating benefit increases in the future. So in this sense the change in the inflation measure seems fair to seniors.
There is a basic problem, however, with using either of these measures. These inflation measures are based on the consumption profile for the average American urban wage-earning household. To the extent that seniors consume different goods and services than the average urban American household, the proposed adjustments to Social Security might overstate—or understate–the rise in the cost- of- living for seniors or put their future finances in jeopardy. If the COLA adjustments understate the cost-of-living, our oldest seniors would be the most vulnerable since they would suffer repeated annual loses in their purchasing power.
When people retire, financial planners generally suggest that household expenses will be about three-quarters of what was needed before retirement. This calculation alone suggests that the items that seniors consume could be very different from what non-retirees purchase. Increased need for healthcare and the different housing situations seniors generally face suggest that these two elements of their ‘market basket’ could be quite different from younger people. Energy price changes also have a smaller effect on seniors since they drive less. (The recent COLA adjustments to Social Security benefits have been very erratic due to energy price spikes.)
What is needed, therefore, is an inflation measure which is based on the goods and services that seniors actually consume and uses the new chained-index methods for calculating price level changes. Then the adjustments to Social Security would be fair.