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Social Security COLA Is Back for 2012

It’s official:  recipients of Social Security (as well as SSI and certain other programs) will get a 3.6 percent cost-of-living adjustment (COLA) in January 2012.  For most enrollees, higher Medicare premiums will offset some of that increase, but other enrollees will actually see their premiums decline.  COLAs preserve the purchasing power of elderly or disabled beneficiaries and are a crucial part of the safety net — something policymakers should recognize as they debate tying benefit levels to a different measure of inflation.

This will be the first COLA in those programs since January 2009.  Led by high energy prices, overall consumer prices peaked in the summer 2008 and then fell sharply.  Fortunately for recipients, their benefits didn’t go down even when prices fell.  Now that prices have surpassed their summer 2008 level, COLAs will resume.

Social Security benefits are modest, averaging a bit over $1,000 a month.  For the average retired or disabled worker or widow, the upcoming COLA will mean a benefit increase of about $40 a month.  And for most beneficiaries, Social Security is the only income they’ll get that’s guaranteed to last their lifetime and to keep pace with inflation.

Most Social Security beneficiaries over 65 — and most disabled beneficiaries under 65 — participate in Medicare and have Part B premiums withheld from their checks.  While the Part B premiums for 2012 won’t be announced for another few weeks, we expect that for the vast majority of beneficiaries, their COLA will more than offset any premium increase.

Here’s why:  a hold-harmless provision prevents enrollees from getting a smaller Social Security check as a result of an increase in Part B premiums; because there has been no COLA for three years, that provision has kept premiums flat since 2009 for about three-quarters of enrollees.  But the law still requires total Medicare premiums paid by all enrollees to cover one-fourth of Part B costs — which means that the rest of enrollees have paid extra.  The resumption of COLAs will spread the costs more evenly.

If the Medicare trustees’ projections hold true, beneficiaries whose premiums have remained frozen since 2009 (at $96.40) will pay $106.60 next year.  That $10 increase is far less than the average $40 boost from the COLA.  And people who didn’t qualify for that freeze — chiefly those who enrolled in 2010 and 2011 and upper-income enrollees — will actually pay slightly lower premiums next year.

The Social Security COLA is based on the Consumer Price Index for Urban Wage and Clerical Workers (CPI-W).  Fiscal commission co-chairs Erskine Bowles and Alan Simpson, as well as the Domenici-Rivlin deficit panel, have urged policymakers to adopt the so-called “chained CPI,” which many economists think is a better measure of inflation.  CBPP has been sympathetic to this idea, so long as it applies to the tax code as well as benefit programs and includes a modest benefit increase for people after they have received benefits for many years.

Other advocates have urged legislators instead to use the experimental CPI for the elderly (CPI-E), which generally gives more weight to changes in the cost of medical care and housing and less weight to food, transportation, and education and communication.

How much difference would these alternative indexes make?  Over the last ten years, COLAs would on average have been 0.3 percentage points lower using the chained CPI and no different using the CPI-E (see table).  Over time, then, all three indexes have told a similar inflation story.  Linking COLAs and tax-code parameters to the chained CPI — with the protections mentioned above — merits a place in a balanced deficit-reduction package.

Average Cost-of-Living Adjustment Using . . .
Last 20 years 2.6% n.a. 2.7%
Last 10 years 2.5% 2.2% 2.5%
Last 5 years 2.3% 2.0% 2.1%
Upcoming COLA 3.6% 3.4% 2.9%