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The Social Security Administration pays benefits to retired and disabled workers who have paid into the system through payroll taxes. The benefit amount for both programs depends on the worker's record of earnings. To help these monthly benefits keep pace with price inflation, Social Security allows cost-of-living adjustments (COLAs); these benefit raises are tied to the Consumer Price Index (CPI), published by the U.S. Bureau of Labor Statistics.
The Social Security Administration, established by the Social Security Act of 1935, has been paying monthly benefits since 1940. The U.S. Congress passed the first adjustment in the benefit amount by an amendment to the Social Security Act in 1950. Beginning in 1975, these raises have been automatically tied to the index of consumer prices, and no longer required an act of Congress. In 2012 the COLA adjustment was 3.6 percent. This was the first increase in the COLA since 2009.
Consumer Price Index and COLAs
Social Security uses the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), a statistic kept by the U.S. Bureau of Labor Statistics, to determine the cost-of-living adjustment. The change in the third-quarter CPI-W from one year to the next determines the COLA adjustment for the following year. Social Security applies COLAs to retirement and disability benefits, as well as to Supplemental Security Income (SSI) benefits. Each year the COLA increase is effective for the December Social Security entitlement of the same yea, which is payable in January of the following year.
If there were no COLAs, the value of a fixed Social Security benefit would gradually decline as inflation affects the price of goods, services and essential expenses such as rent, insurance and utilities. The effect of inflation on the cost of living would erode the stated purpose of the Social Security program: to provide a minimal standard of living for retirees and the disabled.
In recent years COLAs have become a subject of debate among economists. A COLA tied to the rate of inflation of urban workers is not necessarily an accurate measure for costs incurred by retired senior citizens. Because Social Security beneficiaries spend a greater percentage of their income on health care, and health-care costs have been rising more rapidly than other prices, it may make more sense for the Social Security COLA to be tied to a health-care price index instead. On the other hand, predicted future shortfalls in the Social Security trust fund may be an incentive for Congress to be cut back or eliminate COLAs to save money.
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