The Mysterious Cost of Living Adjustment (COLA) - AMAC Foundation
It’s almost amusing – media pundits grasp news about monthly inflation as early as the first quarter of each year and try to extrapolate the early data to predict a Cost of Living Adjustment (COLA) for the following year. It certainly provides something to write about but has little basis in reality for this reason: next year’s COLA is determined using inflation data from the 3rd quarter of the current year, so inflation rates in earlier months carry no weight in the computation of next year’s COLA. Nevertheless, early predictions may seem newsworthy, but it’s important to maintain perspective about the validity of those predictions and what the COLA measurement actually is.
“COLA” is a factor by which government benefits, notably Social Security, may increase annually, based on year-to-year inflation as measured by the Consumer Price Index (CPI). There are several CPI indices, but the one which determines COLA for Social Security is the Consumer Price Index for Urban Wage Earners and Clerical Workers, called the CPI-W. The CPI-W is computed monthly, but only the months in the 3rd quarter (July, August, September) count when computing next year’s COLA. The percentage increase for next year is determined by summing the CPI-W for those 3rd quarter months of this year and comparing that sum to the same period in the previous year. The difference is next year’s COLA percentage, unless there is no (or negative) difference, in which case COLA for next year is zero. For reference, there have been three recent years (2010, 2011, and 2016) when no COLA was given due to lack of year-to-year inflation. Compare those years to the most recent COLA increase of 8.7% for 2023, which resulted from soaring inflation in the 3rd quarter of 2022, compared to inflation for the same period in 2021. You get the point – COLA is awarded well after higher consumer prices have already been suffered, so consumer buying power continually erodes. Money already spent on higher priced goods can never be recovered by a COLA increase, so the best we can hope for is that consumer prices increase more slowly than before.
Pundits are already predicting that 2024 COLA will be around 3% because “inflation is easing.” While that sounds like a good thing, it essentially only means that prices for the goods we buy now are merely increasing less rapidly than they did last year; it doesn’t mean that overall consumer prices are declining. While there may be certain segments where prices actually do go down, the CPI-W measurement evaluates prices across eight categories of products which each have different weighting factors:
- Food and beverages
- Medical care
- Education and communication
- Other goods and services
Thus, price reductions in one category are often offset by price increases in another, and, hence, next year’s COLA will be based on changes to the overall CPI-W. Whatever next year’s COLA turns out to be, higher prices already paid cannot be recovered but, nevertheless, any COLA awarded will be a welcome relief to seniors suffering the inflated cost of consumer goods.
The early predictions for next year’s COLA will almost certainly continue as we navigate through the 3rd quarter of 2023, but the real number won’t be known, nor published, until mid-October. When it is published, another point for those enrolled in Medicare to remember: any increase in next year’s Medicare premium for Part B (and sometimes for Part D) will result in the higher premium amount being withheld from the beneficiary’s Social Security payment. Since both COLA and the higher Medicare premium affect one’s net Social Security payment, many beneficiaries will not see the full 2024 COLA increase in their net Social Security payment. They will, however, receive the full COLA increase to their gross Social Security entitlement.
 There is some discussion about switching COLA to be based on a similar index known as the CPI for the Elderly (CPI-E), but the Department of Labor has not yet endorsed the CPI-E as an official measurement of inflation.