Inflation and the COLA mystery

Q

: I am retired and I live mostly on Social Security plus a little bit of savings. They say my Social Security gets a cost of living increase every year, but it is tiny and it feels like I slip further behind every year. Who decides how much of an increase I get each year and why can’t they make it more realistic?

A

: The Social Security Administration is required by law to adjust your benefits every year for increases in the cost of living. The cost-of-living adjustment (COLA) is based on changes in the Consumer Price Index for Wage Earners and Clerical Workers (CPI-W). The COLA for a given year is calculated as the percentage change in the average CPI-W for the third quarter of the previous year compared to average CPI-W in the third quarter of the year before that. In other words, the 2021 COLA is determined by comparing the average CPI-W for Q3 2020 with the average CPIW for Q3 2019. Using their formula, the 2021 COLA should be about 1.10 percent, assuming September’s inflation looks a lot like July and August. We should see the official announcement from the Social Security Administration sometime in mid-October.

In calculating the CPI each month, researchers at the Bureau of Labor Statistics survey the prices of 80,000 different goods and services around the country. The goods and services are divided into 200 categories and eight major groups. These groups include food, housing, apparel, transportation, medical care, recreation, education, and “other” goods and services.

Each group is assigned a weight that attempts to reflect the spending behavior of the typical American consumer. To the extent that you behave differently than the “typical” consumer, the weights in your consumption basket will be different than the index weights and your “personal CPI” may be very different from the official CPI. If you are interested in exploring the details of the CPI, you can find weights and observed price levels for all the categories and groups in the press release published each month by the BLS. Simply Google “CPI press release”.

Inflation also varies by region. The United States is a very big country with a vast economy, so trying to measure price changes across the entire country is not an exact science. Because we live in an area that experiences higher levels of inflation than many others, it is not surprising that the Social Security COLA doesn’t keep up with the inflation you experience.

To illustrate this point, let’s suppose you have a twin brother living in Georgia. Your twin is like you in almost every way. How might your personal spending differ from his?

For starters, you would probably pay more for a house on the Monterey Peninsula than your brother would pay for an equivalent house in Georgia. You might also find that you spend a larger portion of your budget on housing than he does. As a result, you are likely to be more affected by rising housing prices than he is.

We can see these differences with actual data from the BLS. While the BLS doesn’t track inflation specifically for the Monterey Peninsula or Georgia, they do provide detailed inflation data for the Bay Area and Atlanta. According to the BLS, housing inflation in the Bay Area averaged 3.3 percent for the 12 months ended in August compared with 0.9 percent in Atlanta. Food prices in the Bay Area rose 5.4 percent over that same period versus 4.5 percent in Atlanta. Overall, Bay Area CPI increased 1.6 percent, more than twice Atlanta’s 0.7 percent increase.