Chained CPI – We’re Talking Real Dollars

Social Security recipients on fixed budgets count on their monthly benefits. But a proposed change tossed around in Washington D.C. budget discussions could leave them counting on less to meet their future needs. At issue is the way the cost-of-living adjustment (COLA) is calculated when determining Social Security benefit increases.

As it is now, benefits can increase yearly to counteract inflation — a cost-of-living adjustment calculated using the “CPI-W” method (Consumer Price Index for Urban Wage Earners and Clerical Workers). The proposed change would replace the CPI-W method with the “Chained CPI” method (chained Consumer Price Index).

Both methods estimate inflation by calculating consumer price fluctuation, but in different ways:

  • CPI-W — Prices a basket of goods representing more than 200 items (food, clothing, shelter, fuel, transportation, etc.). It calculates total basket cost and tracks monthly price fluctuations. Average fluctuation is used to set the COLA for the year.
  • Chained CPI — Assumes people adjust buying behavior with changing prices. For example, if one brand’s price increases, consumers will purchase a lower-cost item. As a result, overall basket prices appear to rise more slowly than with CPI-W.

There’s a real difference in dollars between the two methods.  For example, if the government had adopted Chained CPI in 2000, a typical beneficiary would have received approximately 5% less in benefits in 2012 — adding pressure on Social Security recipients, who already absorb and pay for items (like medical care) that outpace inflation.

Example of Social Security Benefits with CPI vs Chained CPI

The fact that this change is even being discussed in Washington is a real stunner – Social Security was once considered the “third rail” of American politics: touch it and you will… well, have a shorter career.

For those interested in learning more about Social Security and Medicare, Principal Funds offers a useful online resource.

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