The Social Security Windfall

As you have probably heard, Social Security recipients won’t be getting a cost-of-living adjustment (COLA) in 2010. Well, at least under current law.

The reason is simple: The annual COLA is based on a measure of consumer inflation from the third quarter of one year to the next. Last year, that measure was boosted by the run-up in energy prices, and Social Security recipients received a 5.8% increase in their monthly payments. That price shock has receded and, as a result, inflation from the third quarter of 2008 to the third quarter of 2009 was actually negative. According to today’s release of September consumer price data, the CPI-W (the inflation measure used to set the COLA) fell by 2.1% since the third quarter of last year.

If Social Security payments were exactly indexed to inflation, that would imply a negative COLA—a reduction in monthly benefits—of 2.1%. But the law doesn’t allow benefits to fall. So monthly benefits in 2010 will be the same as in 2009.

Some observers are portraying this as a hardship for seniors and are suggesting that they should get a special COLA this year. If you put on your green eyeshade for a moment, however, you will realize that the reverse is true. The fact that Social Security benefits will be flat means that seniors are receiving a windfall. Under the logic of cost of living adjustments, those benefits should have fallen by 2.1%. Instead they will be flat. Seniors will thus receive a 2.1% increase in their real Social Security benefits.

That’s why thoughtful budget analysts from across the political spectrum believe that a special COLA is not warranted. See, for example, this piece by Andrew Biggs at the American Enterprise Institute and this piece by Kathy Ruffing at the Center on Budget and Policy Priorities. (In case you aren’t familiar with them, Andrew and Kathy are two of the most knowledgeable people about Social Security on the planet.)

Kathy’s piece includes a nice discussion of alternative measures of cost-of-living (addressing the question of whether the cost of living for seniors may be rising faster than the CPI-W suggests). She also concludes, rightly in my view, that if policymakers fell compelled to act, it should in the form of lump-sum payments rather than any messing around with the COLA structure. President Obama endorsed that idea yesterday.

In a separate piece, Andrew notes that one group of seniors are getting a bum deal from the absence of a COLA: new retirees. They never received the benefit of the too-large 2009 COLA, but will have to bear the burden of no COLAs during the year or two that it will take for inflation to catch up to its 2008 peak.

Finally, another Andrew who’s an expert on Social Security–Andrew Samwick at Capital Gains and Games–suggests that any lump sum payments to Social Security beneficiaries in 2010 be paid for by reducing their COLAs the next time they are positive. The payments would thus provide some stimulus in 2010, but wouldn’t add to the long-term federal debt.

5 thoughts on “The Social Security Windfall”

  1. Hmm. I’m not really sure new retirees are abolutely getting a raw deal. It seems to me there is simply a lag. (For example if prices go up from third-quarter 2009 to 2010 there will be a COLA (per this link: http://www.ssa.gov/OACT/COLA/latestCOLA.html).

    Also, I believe that the average indexed earnings (i.e. the earnings for calculating the highest 35 years of earnings) is NOT adjusted post age 60, so, assuming a worker gets wage increases they are actually gaining relative to the rest of their wages. (Of course, given the current economy, maybe older workers are experiencing wage declines). Anyway, this 1/35th earnings ‘increase’ could somewhat offset the COLA ‘loss.’

    1. Hi chappy — Something bad happened to your link (at least it didn’t work when I tried it around 5:45pm ET). For the overall pool of recipients, my understanding is that the COLA is based on the level of the CPI-W rather than the rate of change, so they won’t get a COLA under the CPI-W surpasses it’s Q3 2008 level (see, e.g., Kathy Ruffing’s discussion) which could take a while.

      1. Ah, yes, I think the link is working now. I drilled down further and indeed it mentions the provision of reverting to the prior year where there is a COLA.

        I guess a better criticism is whether this is truly a ‘notch’ as noted by Biggs. Excepting the COLA two exactly situated retirees except for one day (for example both have the same wage history except that one become eligible for retirement on Dec. 31, 2008 versus one that retires Jan. 1, 2009–also both live to the same age) would still get the same initial benefit, correct? I guess the day-younger retirees lifetime benefit would be slightly lower, but I’m not sure that this is a ‘notch’ per se.

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