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There will be no cost-of-living increase in Social Security payments this January.
This is a big change from last January, when Social Security payments increased 5.8 percent. That increase was much higher than the last year's annual inflation rate of 3.8 percent. This difference came about because of the sharp swings in the prices during 2008. When prices change sharply, it matters when, within the year, the change in the price index is computed.
The Social Security Administration determines the cost-of-living adjustment (COLA) by the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of one year to the third quarter of the next. In contrast, the inflation rate normally reported in the news represents the average percentage change in the Consumer Price Index for All Urban Consumers (formally called CPI-U) during a given calendar year.
The chart below shows why timing matters. The COLA increase that came into effect in January 2009 was computed using the change in the CPI-W from the third quarter of 2007 to the third quarter of 2008, the shaded area on the chart. During that time prices increased rapidly, resulting in a large cost-of-living adjustment to Social Security payments.
But then prices fell sharply in the last quarter of the year, mostly due to the fall in energy prices. Therefore, the annual inflation for 2008, which is computed as the average change in CPI-U between the two vertical lines on the chart, was much lower than the cost-of-living adjustment. Since Social Security recipients received their increased benefits in January 2009, prices have fallen substantially, increasing the purchasing power of the benefits.
Click to enlarge chart.
The situation will be different in 2010. Because of the substantial fall in prices late in 2008, the consumer price index today is below its value from 12 months ago. As the table below demonstrates, CPI-W has fallen by 2.1 percent since the third quarter of 2008. If the cost-of-living adjustments were equal to the change in CPI-W, Social Security payments would have to be reduced starting January 2010.
However, the Social Security Act stipulates that cost-of-living adjustment cannot be negative. Even if prices decline during a given year, COLA is set to zero. Since the introduction of the automatic cost-of-living adjustments in 1975, prices have never declined. Until now.
Thus, even though prices have declined during the past 12 months, the cost-of-living adjustment will be set to zero. Social Security payments will remain unchanged, come January 2010.
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