Real World Economics: Social Security Basics Are Widely Misunderstood

Social Security has just gone through the annual announcement of how much benefits will rise for the next year. The same increase also applies to Supplemental Security Income, or SSI, along with VA disability compensation and retirement payments for both military and federal civilian workers.

For the 76 million people covered by programs run by the Social Security Administration and related systems, that adjustment matters a great deal.

Online personal finance sites often trumpet it as a “big increase,” but many recipients are more likely to complain that it is too small than to feel newly affluent. Far fewer people ask whether this automatic annual adjustment, now in place for more than half a century, is truly efficient, fair, or in need of reform.

One common complaint begins with a misunderstanding. Some people believe the cost-of-living adjustment is based on only three months of prices, which sounds wrong but is often repeated.

In fact, the adjustment reflects 12 months of price changes. It is not a December-to-December comparison, but a comparison of third-quarter averages. In practice, the calculation compares the average CPI for July, August, and September of one year with the average for those same three months in the prior year.

The reason for this method is practical. The Social Security Administration needs the increase before year-end so it can calculate benefit amounts. Recipients receive payments in three batches on the second, third, and fourth Wednesdays of each month. At the same time, the Bureau of Labor Statistics needs time to compile and release the CPI for the month just completed, which means a December figure would not be available soon enough.

The agency could instead use a single month, such as September or October, compared with the same month a year earlier. But monthly prices can swing sharply. A temporary spike in one September, or a temporary dip in another, could make the resulting COLA too high or too low compared with the broader year-long trend.

There is also confusion about what the CPI actually is. News reports often describe it as a percentage change, but the CPI itself is not a percentage. It is an index number, with a base set at 100 for a chosen reference period. For many years, that reference point was 1967. Later, the CPI base was updated to the average of prices in 1982 through 1984.

The index used for cost-of-living adjustments, the CPI for Urban Wage Earners and Clerical Workers, was recently reported at 330.654 for a single month. That means prices were about 3.30654 times their average level in the 1982-1984 base period. But the COLA is based on the third-quarter average, which was 328.746.

Looking back at the prior year, the comparable third-quarter average was 317.265. Dividing the newer figure by the older one produces an increase of 1.03619, which rounds to 3.6%. That means third-quarter prices were 3.6% higher than a year earlier, so benefits for the following year will rise by that amount.

A third-quarter comparison will not always match a December-to-December comparison exactly, but over time it tends to come very close. Sometimes it will run a little high, sometimes a little low, and over many years it should line up with the broader rise in consumer prices.

A second frequent complaint is that there are multiple consumer price indexes. In fact, there are different measures for different purposes. The two best known are the CPI for All Urban Consumers, which covers about 90% of the population, and the narrower CPI for Urban Wage Earners and Clerical Workers, which covers roughly 30%.

The CPI-W is the one used to determine annual Social Security COLAs. That has fueled claims that the public is somehow being shortchanged by using one index instead of the other. But the difference is minimal. Using the CPI-W, a monthly benefit of $1,000 in 2000 would grow to $1,869.56 in 2026. Using the CPI-U, it would be $1,871.05.

There is, however, a more serious objection. Older people tend to spend differently from the general population, so a special index for elderly households might be a fairer way to set retiree adjustments. Such an index could potentially produce larger increases.

That index already exists in research form: the R-CPI-E, or Research Consumer Price Index for the Elderly. The “research” label means statisticians are still testing it, and it has smaller samples and less detail than standard indexes. Over the same quarter-century period, using this measure would have raised a $1,000 payment in 2000 to $1,917.21 in 2026. That extra $46 a month compared with the two general indexes would matter to many recipients. Congress could adopt the change with a simple bill, but the institution is so dysfunctional that even that modest step has not happened.

Short-run disputes over formulas matter less than the larger long-term question: is it reasonable that payments for 76 million people, and eventually nearly everyone, depend so heavily on decisions and quirks from more than half a century ago? Can a single starting point set in 1972, then carried forward 54 times by an imperfect measure, really be considered fair or economically efficient today?

Congress debated fair and sustainable benefit levels nine times in the 32 years between the first benefit checks in 1940 and the adoption of indexation in 1972. Why has it not seriously reviewed the COLA system since then? And why has it not revisited any major part of Social Security since the recommendations of the Greenspan Commission in 1984?

The answer leads back to a half-century-old episode involving a powerful congressman and a scandal with a Washington, D.C., stripper who called herself Fanne Foxe, the Argentine Firecracker.

During Richard Nixon’s first term, Wilbur Mills, a dominant Democratic congressman from Arkansas, was planning a run for president. First elected in 1938 at age 30, he rose quickly and by 1972 had chaired the House Ways and Means Committee for 14 years. Because that committee controlled tax legislation and major spending programs, including Social Security, Mills may have been the most powerful member of Congress.

Mills was also active on Social Security policy early on. In 1969, when the CPI rose 4.7%, newly inaugurated Nixon proposed a 7% benefit increase. Mills pushed through a 15% hike, which Nixon reluctantly signed. The following year, after a 6.2% rise in the CPI, Nixon’s budget called for a 6% increase, but Mills countered with 10% and prevailed again.

Inflation slowed in 1972, but rising living costs remained a major election issue. Nixon offered a 5% increase plus a permanent annual COLA. Mills embraced the COLA idea but first outbid Nixon with a 20% overall increase. Nixon objected, but eventually gave in because of broad public support and firm congressional backing. In a preview of later presidential style, Nixon ensured that every new monthly check carried a printed statement saying the increase had been signed into law by him.

Mills won the policy battle. He did not run in 1972, but he still seemed well positioned with voters for the future and planned to keep pushing large benefit increases.

Yet his private life collapsed. Time magazine once called him one of Washington’s most disciplined, straight-laced, and intensely focused lawmakers. He was not known as a womanizer. Still, despite being a devout Methodist, his growing dependence on alcohol led him into a 17-month affair with Fanne Foxe, who was 27 years younger than he was.

The affair ended badly. Police were called twice in incidents involving the couple. The second time, Foxe was pulled from the Tidal Basin near the Jefferson Memorial with two black eyes. By the end of his term, the disgraced Mills returned to Arkansas for treatment and later spent years helping establish alcohol treatment efforts in his home state. His former companion returned to performing under the name Fanne Foxe, the Tidal Basin Bombshell.

It is easy to laugh at the scandal, but while using benefit increases for cynical political advantage, Mills understood Social Security in a way few members of Congress in recent decades have matched. He also had the willingness to act on that understanding.

The program could still be made more sustainable, more efficient, and more fair. Doing that, however, would require knowledge and integrity in Washington that are not especially abundant now.