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New York Fed economists Bart Hobijn and David Lagakos find that social security benefit levels for seniors would increase if benefits were adjusted for inflation using a price index that reflects the spending patterns of the elderly, rather than those of workers. However, such a change could also speed up insolvency of the social security trust fund by as many as five years.
Hobijn and Lagakos explain that social security benefits are automatically adjusted for inflation each year to prevent a decline in the purchasing power of retirees' benefits. These cost-of-living adjustments are based on the CPI-W, a Bureau of Labor Statistics measure of price changes in the average set of goods purchased by workers. Yet there are significant differences between the spending habits of the typical worker and the typical retiree. Seniors, for instance, devote a much larger share of their income to medical care.
The study notes that because of these differences, some advocacy groups for the elderly would like to see benefits adjusted using an index that reflects spending by older Americans. Since the early 1980s, the BLS has calculated such an index: the consumer price index for elderly consumers, or CPI-E.
Hobijn and Lagakos consider how use of the CPI-E to index benefits would affect the level of benefits paid as well as the future resources of the social security trust fund.
The authors find that between 1984 and 2001, inflation as measured by the CPI-E has been consistently higher than CPI-W inflation, with a 0.38 percent average annual difference. Accordingly, they estimate that if the CPI-E had been adopted in 1984, the average benefit in 2001 would be 3.84 percent higher, or roughly $408 more per year per recipient.
However, the analysis also reveals that if the CPI-E were introduced today, the social security trust fund could become insolvent up to five years sooner than the currently projected 2043. The actual timing depends on how much higher future inflation is for seniors than for workers.
Hobijn and Lagakos' findings also suggest an important trade-off facing policymakers: maintaining the purchasing power of seniors over time versus prolonging the solvency of the social security trust fund.
Bart Hobijn is an economist and David Lagakos is an assistant economist, both at the Federal Reserve Bank of New York.