Here's Why Seniors Just Received the Smallest Social Security Raise on Record

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There probably isn't a more important social program for retirees than Social Security. According to a 2015 Gallup poll, 59% of all surveyed seniors rely on Social Security to be a "major" part of their monthly income, with another 31% expecting it to be a "minor" source. Another way to angle this data is that nine in 10 seniors could struggle to live comfortably during their golden years without Social Security.

However, Social Security's future is somewhat in doubt. The program itself is not headed to bankruptcy, so go ahead and throw that myth out the nearest window. But according to the Social Security Board of Trustees report in 2016, the program's more than $2.8 trillion in spare cash could be depleted by 2034. Lengthening life expectancies and a declining worker-to-beneficiary ratio caused by the ongoing retirement of baby boomers are the primary reasons why the program is projected to switch from a cash inflow to an outflow by 2020. Should the program run out of spare cash, benefits could be cut by up to 21% across the board to keep Social Security solvent through 2090.

Recent COLAs are failing Social Security beneficiaries

In the interim, current retirees are counting on annual cost-of-living adjustments, or COLAs, to drive their benefits higher. Between the mid-1970s and mid-1990s, Social Security COLAs were substantive, and seniors often received "raises" that didn't weigh on their purchasing power. Things have changed a bit over the past 20 years. In fact, since 2009, Social Security beneficiaries have had three years where they didn't receive an increase in their benefits at all.

Chart by author. Data source: Social Security Administration.

Three weeks ago, the Social Security Administration announced the highly anticipated COLA for the upcoming year, but it wound up being yet another disappointment for seniors. The 0.3% COLA for 2017 represents the smallest increase on record (note that I've differentiated increases from the three years where Social Security's COLA didn't budge at all). Previously, the 1.3% COLA in 1998 was the smallest on record.

Small or nonexistent COLAs are worrisome for a number of reasons. In particular, inflation from other areas of the economy isn't slowing down, which is reducing seniors' purchasing power. Medical care inflation has outpaced that of Social Security COLAs in all but two years since 1981, and rental inflation is handily outpacing the raises Social Security beneficiaries have received in recent years. If COLA doesn't accurately reflect the higher costs seniors are paying, they could struggle to make ends meet.

Here's why Social Security's COLA is so anemic in 2017

Why was the COLA for the upcoming year so disappointingly low at 0.3%? To answer that question, we'll have to dive into the measure that determines inflation for the Social Security Administration.

The Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, is the benchmark for inflation that determines whether or not Social Security benefits increase or stand pat (deflation can never cause benefits to fall). The average CPI-W reading from the third quarter of the previous year serves as the baseline figure, and the average third-quarter CPI-W reading from the current year acts as the comparison. If the average moves higher in the current year, then Social Security beneficiaries receive the percentage difference rounded to the nearest tenth of a percent. As noted above, if there's a year-over-year drop in the price of the goods and services that the CPI-W covers, then benefits remain flat.

Image source: Getty Images.

So what happened that caused the CPI-W to rise by a diminutive 0.3%? Though the Bureau of Labor Statistics doesn't break out specific data for the CPI-W as it does for the Consumer Price Index for All Urban Consumers, or CPI-U, we can get a pretty good idea of what happened by examining the most recent CPI-U data from the BLS.

Based on the BLS' September data release, energy and food costs absolutely crushed seniors' hopes of getting a healthy raise in 2017. On an adjusted 12-month basis, food costs have deflated by 0.3%, with food at home (minus 2.2%) playing a key role in that decline. Energy prices were an even larger factor, with gasoline costs dipping 6.5% and total energy costs falling by 2.9%. In fact, just the food and energy industries were enough to provide a negative 0.7% drag on the overall 12-month unadjusted CPI-U. In simpler-to-understand terms, seniors need crude prices to rebound and grocers to regain their pricing power if they hope to net a healthy COLA for 2018.

One possible solution

One potential fix to Social Security's anemic COLAs that's been floated around -- but which has yet to gain any traction on Capitol Hill -- is to completely reconfigure how inflation is calculated for Social Security purposes.

Instead of using the CPI-W, some pundits have suggested switching to the Consumer Price Index for the Elderly, or CPI-E. The CPI-E strictly factors in the spending habits of people aged 62 and older. Switching gears to the CPI-E could certainly make sense, given that two-thirds of the 60 million-plus beneficiaries enrolled in Social Security are retired workers.

Image source: Getty Images.

The advantage the CPI-E offers relative to the CPI-W is that it places a considerably larger weighting on medical expenditures and a modestly higher weighting on housing costs. Conversely, it deemphasizes less important expenditures for seniors, such as apparel, entertainment, and education spending. The thinking is that if the CPI-E is used instead of the CPI-W, seniors would receive an annual COLA that's far more representative of what's going on with the costs important to them than they are right now with the CPI-W.

On the flipside, there are concerns with such a switch. For example, using the CPI-E could result in larger annual COLAs that wind up accelerating the cash depletion date for Social Security. Secondly, the CPI-E doesn't factor in Medicare Part A (inpatient services) costs, and these are traditionally the largest medical costs for seniors. Finally, the CPI-W factors in far more households than the CPI-E, meaning lawmakers may view it as the better measure of inflation.

A change in how the Social Security Administration tracks inflation seems unlikely at the moment, so weaker energy and food prices could continue to weigh on seniors' Social Security COLAs in the near future.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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