Monthly checks on social security benefits are likely to increase the most in 40 years next year.
Many retirees welcome this news because they have been complaining for years that the annual social security cost adjustments have been too small. For example, COLA, which came into force in January this year, was only 1.3%.
However, their reaction betrays a fundamental misunderstanding of what COLA represents. Economists call this misunderstanding the “illusion of inflation” or the “illusion of money” and it will not end the confusion.
This is because the Social Security COLA – in theory – will not leave you better or worse than before. If inflation is high, you will need a higher COLA to recover. In that case, you are no richer than you would be in a low-inflation environment with a correspondingly low COLA.
We certainly do not yet know for sure what the social security COLA for 2022 will be, as it is based on the 12-month inflation rate for the third quarter of this year. This means that the exact COLA is not known until the September inflation figures are scheduled for 13 October. Alicia Munnell, director of the Center for Retirement Studies at Boston College, estimates that this is 6%. If so, COLA is the highest since 1982 at 7.4%.
Different inflation measures
In theory, therefore, there is no reason why this year’s higher COLA should make you happier than last year’s much smaller COLA.
Of course, theory and practice do not always coincide. In practice, COLA may leave you worse off than before if the inflation measure underlying COLA is faulty. Although a full discussion of the pros and cons of different inflation measures is not included in this column, here is a brief overview of some of the leading candidates for what social security could use:
• THI-W. This is the version that the Social Insurance Agency is currently required by law to use. Formally known as the “Consumer Price Index for All Urban Wage and Clerical Workers” (CPI-W), it differs slightly from the monthly main consumer price index number, which is technically the “Consumer Price Index for All Urban Consumers” (CPI-U). Over the last two decades, the CPI-W has risen at a slightly higher rate than the CPI-U by only 0.1 percentage point per year.
• THI-E. It stands for the Elderly Consumer Price Index and is calculated by the SSA taking into account the different spending habits of the typical elderly person. Over the last four decades, the CPI-E has risen 0.2 percentage points faster than the CPI-W. Although many in Congress have enacted legislation requiring the SSA to designate COLA using the CPI-E, Munnell argues that this may not be worth it. This is due to the fact that most of the historical difference between CPI-E and CPI-W is from the previous to 2002; since then, he notes, there has been virtually no difference.
• Covid-CPI. As I pointed out a year ago, some believe that the COVID-19 pandemic has made the CPI-U and CPI-W a particularly poor reflection of real inflation. This argument is put forward by Alberto Cavallo, Professor at Harvard Business School, which a year ago calculated that real inflation was 0.6 percentage points higher than reported. This year, however, the difference is the other way around: over the last 12-month period, its Covid-CPI has been 0.6 percentage points lower than the CPI.
I will leave the discussion to others about the pros and cons of both and other definitions, but I still want to put them in context. The average monthly Social Security benefit is currently $ 1,543, so even a full percentage point difference in COLA means only $ 15.43. And most differences between different definitions are less than a full percentage point. A tenth of a percentage point means $ 1.54 more – less per month.
This may not be big enough to worry about, given that there are many other pension funding issues that make it much bigger.
When does social security run out of money?
One such bigger issue that is in the news this week is Last report of the Chief Actuary of the Social Insurance Board on the solvency of social security funds. As has been widely reported, this latest report estimates that the two main trust funds (Old Age and Survivors’ Insurance-OASI and Invalidity Insurance-DI) together will not be able to pay 100% of benefits from 2034 onwards than a year ago.
You may be wondering how to equate this conclusion with my analysis, only a week ago, which reported good news in the field of social security financing. There are two reasons:
• It is not entirely correct to say that the Secretary-General is announcing that the social security funds will run out of money earlier than expected. In both the innovations made last summer and last autumn, the chief actuary had already noted that the OASI and DI mutual funds would be exhausted by 2034. His new report this week only confirms this assessment. And this is good news, because it means that, after almost a year of further analysis, some of the most nightmarish scenarios for social security funding have not materialized.
• I relied on my “good news” assessment from the Congressional Budget Office’s actuarial report, which calculated that the OAS Trust Fund would run out of money in 2022 – instead of 2031, as previously thought. In his latest report, the chief actuary estimates that this trust fund in particular will not be exhausted until 2033, a year later than the CBO. That is also good news.