October 25, 2010

No COLA for you!

The government recently announced that there would be no monthly cost of living increase (COLA) for social security recipients for the second straight year. What an outrage, right?

Social Security benefits (SSI) are a major political hot topic, especially during election season. Just today I heard a radio campaign ad stating that so-in-so republican said Social Security is a broken system that needs to be eliminated. Of course you could not tell what the candidate’s actual belief was based on the 5 second sound byte that, by the way, never actually mentions Social Security. The major issue with SSI is that too many Americans rely on it as their major or even sole source of retirement income. It has become a much too relied on crutch, when it should only be a supplemental source of an individual’s income after they leave the labor force.

The outrage stemming from the governments recent announcement is not as bad as the story would lead you to believe. Yes, there will be no COLA increase for the 2nd straight year, but what about the $250.00 one-time bonus paid to SSI recipients in 2010? When you consider that the average SSI benefit is $1,072.00 per month, that $250.00 bonus equates to an increase of 2% from the previous year. Also, since the COLA is based on the CPI W (consumer price index for urban wage earners and clerical workers), the lack of an increase in 2009 was really a non-issue due to the fact that, according to the CPI W, we did not experience any inflation. In fact, there was deflation. The CPI W in 2009 was 205.70. In 2008 it was 206.744 (www.ssa.gov/OACT/STATS/cpiw.html). According to this data the inflation rate is calculated as 205.70-206.744/205.70x100, which equates to a -0.50% decrease in prices from 2008 to 2009. The rate of deflation, coupled with the $250.00 increase in annual income, would have increased overall purchasing power of consumers receiving SSI benefits by 2.5%. According to consumer theory this 2.5% increase in income/purchasing power would shift the consumer’s budget line out from BL1 to BL2, increasing the consumers affordable set in the process (x1, e1, y1 to x2, e2, y2; assuming normal goods). This move would shift the consumers indifference curve from u1 to u2 making them better off during this time period.

In 2010 the CPI W rose from 205.70 in 2009 to 212.568 which equated to a rate of inflation of approximately 3.4% (212.568-205.70/205.70x100). When taking into consideration the one-time bonus of 2.5%, and the 0.50% deflation in 2009 the total inflationary increase for SSI recipients who received the bonus was less than 1% (0.90%). That is not too bad considering the CPI tends to overstate the level of inflation. Since the CPI is calculated based on a fixed basket of goods, it does not take into consideration the consumers ability to substitute toward goods whose prices have fallen or the introduction of new goods that could potentially increase the real value of the dollar.
In an effort to ease SSI recipient’s fears, the Obama administration is considering a proposal to issue a 2nd $250.00 bonus in 2011. If this is done, assuming the average SSI benefit is $1,092.83 per month (2010 average plus $250.00 annual bonus in 2010) the actual level of increase in the average SSI benefit would be roughly 1.9%, or $1113.66 per month total new benefit. With that 1.9% increase, coupled with the 2.50% increase from 2009, SSI recipients would actually be ahead of inflation by 1.5% (212.568-206.744/206.744=2.9% increase in prices from 2008-2010), on top of the fact that the CPI tends to overstate the level of inflation.

An argument could be made that individuals receiving SSI benefits rely on the annual increases received to maintain a comfortable standard of living. But before people panic about a halt on their annual COLA, wouldn’t it be best to ease their fears by helping them understand why they are not receiving one? Wouldn’t it be beneficial to use situations like this to spark resurgence in personal savings, so people could wean themselves off of their reliance on a government run retirement program? Based on the government’s track record with spending and budget management, especially by the last two administrations, wouldn’t you be wise to plan for your retirement future? If we did, at least we would have to worry about whether or not we were going to get our annual increase in SSI. Prices on the other hand, would be a whole different story.


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