The 8 Major Spending Categories That Affect Social Security's Cost-of-Living Adjustment

Each and every month, more than 42 million retired workers receive a check from the Social Security Administration (SSA). Of these more than 42 million retirees, an estimated 62% count on their check to provide at least half of their monthly income. Without this income, millions of retirees would probably be struggling to make ends meet.

Thankfully, Social Security is somewhat self-sustaining. Despite pervasive rumors that the program could go bankrupt, that's not something that could happen, assuming Congress doesn't alter how the program is funded. You see, Social Security is funded in three ways: payroll taxes, the taxation of benefits, and interest income earned on its excess cash. Payroll taxes accounted for 87% of all revenue in 2016, and as long as Americans continue to work, new revenue will continue streaming into the program.

The unfortunate aspect of Social Security for seniors is that current payout levels may not be sustainable beyond 2034. According to the latest report from the Social Security Board of Trustees, the program will begin paying out more in benefits than it's collecting in revenue beginning in 2022. By 2034, nearly $3 trillion in excess cash will be completely exhausted. The Trustees report estimates that an across-the-board cut in benefits of up to 23% may be needed to sustain payouts through 2091.

The purchasing power of Social Security dollars is dwindling

Yet this may not be the biggest concern for seniors. A more front-and-center issue has been the deterioration of the purchasing power of their benefits over the past couple of decades. A recent analysis from The Senior Citizens League found that what $100 in Social Security benefits purchased in 2000 only buys $70 worth of goods and services today.

Social Security's cost-of-living adjustment, or COLA, is supposed to allow seniors' benefits to keep up with inflation -- the key phrase there being "supposed to." Clearly, based on the purchasing power erosion measured by TSCL, this isn't happening. Let's take a deeper dive into Social Security's COLA so you can get a better understanding of what factors go into the "raises" that beneficiaries receive most years.

The official inflationary tether used by the SSA is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The average reading of the CPI-W for the third quarter of the previous year (July through September) serves as the baseline reading, whereas the average reading from the third quarter of the current year serves as the comparison. If the prices for the basket of goods and services measured increases year over year, beneficiaries receive a commensurate percentage increase in benefits rounded to the nearest 0.1%. If prices fall from one year to the next, benefits remain the same for the following year. That means, thankfully, that benefits don't drop if the U.S. faces deflation.

Eight major goods and services categories covered by the CPI-W

Digging deeper, you may be wondering what goes into the CPI-W's measurements. Although more than 200 items are taken into account, below you'll find the eight major spending categories that, according to the Bureau of Labor Statistics (BLS), help determine whether or not beneficiaries, and more specifically seniors, receive a raise. In parenthesis you'll note examples provided by the BLS of what kinds of expenses fall into each major spending category.

Food and beverages (cereal, milk, chicken, wine, full-service meals, snacks)
Housing (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)
Apparel (men's shirts and sweaters, women's dresses, jewelry)
Transportation (new vehicles, airline fares, gasoline, motor vehicle insurance)
Medical care (prescription drugs and medical supplies, physicians' services, hospital services)
Recreation (televisions, toys, pets and pet products, sports equipment, admissions)
Education and communication (college tuition, postage, telephone services, computer software and accessories)
Other goods and services (tobacco and smoking products, haircuts and personal services)

In recent years, seniors have been losing their purchasing power as a result of higher inflation rates in medical care and housing. In fact, medical care inflation has topped Social Security's COLA in 33 of the past 35 years. While these expenses are factored into the CPI-W, urban and clerical workers tend to have lower medical care expenditures and housing costs compared to seniors. Therefore, the CPI-W tends to under-represent medical care and housing costs, while overemphasizing other expenditures, such as apparel, transportation, and education. This is the primary reason why Social Security benefits for seniors aren't accurately keeping up with inflation.

If there is a silver lining in the upcoming year for seniors, it's that the transportation category is liable to push Social Security's COLA a bit higher than was expected just a few months prior. Hurricanes Harvey and Irma disrupted production at refineries and lifted crude prices, leading to an increase in gasoline prices. Higher gas prices will act as an inflationary pressure on the transportation category, potentially netting seniors a COLA that's probably around 2%. Though that's far from great, it's much better than the minuscule "raise" of 0.3% for 2017.

If you're curious what the future may hold for Social Security's benefits, pay attention to CPI data releases from the BLS and note the inflation or deflation associated with these eight major spending categories.

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