Cost-of-Living Adjustments and the Alternate Price Indexes

For many years, there has been a need to make cost-of-living adjustments to federal benefits to ensure they aren’t outpaced by inflation. Typically, a consumer price index would be used to calculate the exact adjustments required, and this would maintain a similar level of purchasing power for all federal workers. With these small adjustments, it ensures the money earned isn’t suddenly less valuable due to inflation.

Maintained by the Bureau of Labor Statistics, there are four different consumer price indexes used by Social Security and a number of other federal retirement programs. However, what would happen to federal spending and the benefits of the masses if we were to switch indexes? In this guide, we’re going to answer this exact question.

Impact of Switching to CPI-U or CPI-E

Using historical inflation information, the U.S. Government Accountability Office predicted future inflation and analyzed how program costs and retirement benefits would be affected should we switch to a different consumer price index (CPI). Initially, the difference between CPIs was considered small when assessing the annual impact but then gaps started to open over time.

As an example, what if we switched to the Chained CPI-U? Despite considering how consumers are able to purchase various products before and after inflation, using this CPI would lead to small reductions in program costs and COLAs (cost-of-living adjustments). Elsewhere, the CPI for the Elderly (CPI-E) was also tested; as the name suggests, this is an index that considers the elderly generation’s spending.

In terms of annual program costs and COLAs, the CPI-E would lead to a small increase. However, it was over a period of 30 years that the differences were really noted. Between the period of 2003 and 2033, GAO considered monthly benefits on CPI-E and CPI-U compared to the index we use now – the CPI for Urban Wage Earners and Clerical Workers (CPI-W). Using predictions for inflation, there would only be a few dollars of difference in the early years (just as we saw with the annual differences above). Yet, the monthly difference after 30 years would be over $100 using a hypothetical beneficiary earning the average national wage.

For people with lower incomes and who have received benefits the longest, they will benefit the most from switching indexes. Why? Because lower-income individuals tend to rely more on federal retirement programs and the changes to the COLA will accumulate over a period of months and years.

Lowest Income Quintile

-Chained CPI-U – Using hypothetical COLAs as a base for estimates, a 30-year period would lead to a 6% decrease in total retirement income if Social Security was linked to the Chained CPI-U (for a household in the lowest income quintile).

-CPI-E – Alternatively, the same households and the same conditions would have a 4% increase over a period of 30 years if tied to the CPI-E.

As mentioned previously, lower-income households were used by the GAO since they would be affected more by the switch. For households in the highest income quantile, both indexes yielded a change of just 1%.

Summary

Why was this report created? Every so often, the GAO is asked to calculate the COLAs for different CPIs for the benefits allowed by certain federal programs. For example, this one focused on federal retirement programs. In the full report, GAO made no recommendation to change since there were doubts about the two indexes tested (shown below), but it still makes for an interesting debate for the future.

-Chained CPI-U – Based on preliminary data and subject to change a year after being released, this would create implementation issues.

-CPI-E – Considered an ‘experimental’ index, the cost of improving it to an official index would require heavy investment (a potential $110 million per year).