What is a consumer price index?
The U.S. Bureau of Labor and Statistics (BLS) determines Social Security cost-of-living adjustments (COLAs) each year using
establishedconsumer price indexes (CPIs).
CPIs are systems by which our government can measure price changes in several different spending areas for a particular demographic or for American consumers in general. Together, these spending areas represent a “market basket of goods and services.” That basket includes things like:
To determine what that market basket should consist of–and how those items should be weighted in terms of importance to a particular group–the BLS regularly studies spending habits and data provided by thousands of families representative of that group. Based on the information these individuals provide, the BLS can create a CPI that accurately measures costs faced by that group and assess its financial health.
With a CPI, we can track the overall health of our economy, the level of inflation consumers are experiencing, and make adjustments to programs like Social Security to make sure benefits keep in line with rising or falling costs.
Currently, the BLS uses two CPIs to measure price changes and spending in our country, the CPI-U (for Urban Consumers) and the CPI-W (for Urban Wage Earners and Clerical Workers).
CPI-U: Urban Consumers
This broad price index accounts for spending and prices affecting all urban consumers, about 88% of the U.S. population. This group includes Americans at all economic levels in a variety of career fields (including retired) living in urban or metropolitan areas.
CPI-W: Urban Wage Earners and Clerical Workers
If the CPI-U represents all urban consumers in our society, the CPI-W reflects a specific subset of these consumers. The CPI-W represents all urban hourly wage workers and clerical workers, approximately 32% of the U.S. population. To be part of this group, a household must contain at least one member having worked 37 weeks or more in the past year at an hourly wage or clerical position.
The CPI-W weights food, clothing, and transportation heavier, and housing, healthcare, and recreation less than the CPI-U.
This is also the current price index used to calculate cost-of-living increases for all Social Security beneficiaries.
The CPI-W and Social Security
Social Security activists have criticized the use of the CPI-W to determine COLA increases for years.
The CPI-W makes a distinction between largely lower income individuals and the entirety of a city’s population. This is a good thing when it comes to measuring how rising costs are truly affecting people. Inflation in certain areas will hit this group much harder–and their needs and spending habits do not reflect the spending habits of higher income residents.
Being a lower income group, the CPI-W was a much better way to assess inflation for seniors and make adjustments to their Social Security payments than the CPI-U.
That being said, the CPI-W’s market basket of goods and services still doesn’t accurately measure costs faced by seniors and retirees. In fact, because of the way the market basket is weighted, it tends to punish seniors when the time comes to determine a COLA.
For example, as mentioned, the CPI-W puts more of an emphasis on transportation spending and less of an emphasis on healthcare spending. But retirees spend a great deal more on healthcare than other groups and tend to spend less on things like gas since they don’t commute regularly.
In 2016, retirees received no COLA specifically because the cost of oil plummeted. Once the entire market basket was taken into account, the low cost of gasoline offset rising costs in other areas.
Healthcare, an area where prices can always be expected to rise quickly, is weighted lower than gas. Despite medical costs skyrocketing, cheap gas prices made the BLS determine that there was no or low inflation overall.
As a result, no COLA was issued–bad news for seniors spending outrageous sums on healthcare and no longer driving. And definitely unfair.
A new CPI for seniors?
To combat the imbalance retirees face due to the CPI-W, several legislators have proposed creating a new subset strictly to gauge prices that affect older Americans. This new CPI would be used to make COLA adjustments rather than the CPI-W.
There have also been proposals to switch to a CPI that will help to extend the solvency of the Trust Fund.
The chained CPI
The chained CPI (C-CPI-U) is one such alternative. Developed by the BLS and presented as an alternative measure to the CPI-U, the C-CPI-U adjusts the CPI-U under the assumption that in an inflationary or expensive market, consumers will turn to cheaper or generic products or make substitutions for goods and services to save money.
The effect of this adjustment is inflation measurements would be lower. If consumers actively reduce their spending as costs rise, those consumers naturally offset part of the inflation by changing their lifestyle. COLA increases, then, wouldn’t need to be as high.
Because of this, the chained CPI is deemed a benefit cut by Social Security supporters. Under this CPI, COLA increases are smaller and slower, but proponents say this will go a long way towards restoring the health of Social Security in the long term.
CPI-E (for the Elderly)
The CPI-E was developed in 1987 by the BLS in response to amendments to the Older Americans Act of 1965. Congress directed the BLS to develop a price index specifically for Americans age 62 and older.
Studies of senior spending patterns indicate Americans over 65 spend two to three times as much on healthcare as other groups. Meanwhile, the costs of healthcare always rise much faster than other items factored into the market basket of goods.
The CPI-E weights this spending, producing a COLA that rises more rapidly than the CPI-W or the chained CPI. In comparing COLAs under both models between 1982 and 2014, the CPI-E rose 0.2 percentage points above the CPI-W each year, and the chained CPI reduced COLAs by 0.3 percentage points.
The CPI-E is championed by many legislators, but currently, it is still in experimental stages due to the small sample sizes used to develop it. With greater sampling and more analysis, we will have a more accurate understanding of what the CPI-E can do for seniors.