Why Social Security recipients might feel the pinch

Image: Social Security check
Next year’s increase for Social Security recipients and others who receive government benefits will be roughly 1.5 percent. That follows a 1.7 percent increase for 2013. Bradley C Bower

Social Security recipients aren’t expected to get much of a benefits increase next year, and that’s raising the question of whether the government does a good job estimating how much it really costs seniors to maintain their standard of living.

“The real problem here is that the cost of living adjustment that Social Security uses doesn’t fully reflect the prices that older Americans face,” said Richard W. Johnson, director of the program on retirement policy at the Urban Institute.

The government calculation of Social Security cost of living adjustments – or COLAs – has for years been based on the Consumer Price Index for Urban Wage Earners and Clerical Workers. Many economists expect that Social Security recipients will receive a paltry raise in 2014, because that measure of price increases for things like food and energy has remained low in recent months.

The Associated Press, based on in its analysis of the government data available, is projecting that next year’s increase for Social Security recipients and others who receive government benefits will be roughly 1.5 percent. That follows a 1.7 percent increase for 2013.

It’s not clear when the government will release the official cost of living adjustment. The Labor Department was supposed to put out a report this week that would be used to calculate it, but that has been delayed by the government shutdown.

Many economists quibble with the government calculation of COLA increases because seniors have different expenses than younger Americans. Older Americans tend to have higher health care expenses, for example, and they tend to be more clustered in certain geographic areas.

“I don’t think we have a really good measure of what the inflation rate faced by the average senior is,” said Alan Auerbach, director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley.

Still, he argued that in general retirees have fared pretty well in recent years compared to younger Americans, because they haven't been as affected by the tremendously difficult job market. 

The Bureau of Labor Statistics has for years been calculating an experimental consumer price index for people ages 62 and older, and that has historically had a slightly higher overall inflation rate than the index the government currently uses to make Social Security adjustments. But because the sample size is relatively small, the government agency says the results should be looked at with caution. 

The method the government uses to calculate Social Security adjustments has become a bigger issue recently because the weak economy and low inflation has led to several years of low — or no — cost of living adjustment.

Doug Handler, chief U.S. economist with IHS Global Insight, said a big danger in having paltry increases is that it leaves retirees on a fixed income with little buffer if there is a sudden spike in the price of a necessity, such as home heating costs.

Handler also noted that said it’s becoming a bigger issue because the U.S. population is generally aging, leading to more Americans relying on Social Security.

That’s raising another worry: Whether there will be enough money in the Social Security coffers to fund benefits for the coming decades.

One proposal politicians have floated for getting a handle on Social Security expenses would be to switch to a different consumer price index, called the chained CPI, for calculating benefits increases.

The chained CPI assumes that when prices go up for one thing, like beef, people react by buying a cheaper thing, like chicken. Many economists say the effect of that switch would be even lower benefits increases in years to come.

Joel Naroff, chief economist with Naroff Economic Advisors, said switching to the chained CPI would save money, but it would mean that annual Social Security benefit increases would be even further removed from the actual changes in the costs that older Americans face.

“If you’re going to say that you want to have a cost of living adjustment for Social Security, then find the measure that most closely matches their consumption bundle,” he said. “Otherwise, stop the game. Call it: I want to lower the rate of increase of Social Security payments and that’s all I’m trying to do.” 

Allison Linn is a reporter at CNBC. Follow her on Twitter @allisondlinn or send her an e-mail.