Social Security will increase retiree payments by 8.7%, the largest cost-of-living increase since 1981. It happens as wages and savings continue to be eaten away by sky-high inflation.
The revisions, which are slated to go into effect in January 2023, were made following the publication of the consumer price index data for September 2022, which showed inflation increasing by 0.4% more than anticipated during the month.
Tens of millions of pensioners and recipients of supplementary security income, who may be having trouble making ends meet since inflation has risen during 2022, would undoubtedly welcome the automatic adjustment. It wasn’t always the case, though, and other government benefits and programs handle inflation in different ways.
At Rice University’s Baker Institute, John Diamond, the director of the Center for Public Finance, explains the background of the Social Security cost-of-living adjustment, or COLA, as well as what other benefits are modified for inflation and why the government makes these changes.
1. How quickly are living expenses increasing?
According to the most recent statistics, which covers September, average consumer prices are up 8.2% from a year ago. The 0.4% monthly growth was double what Reuters-surveyed analysts had predicted.
Worse still, core inflation, which includes volatile food and energy costs, increased by 0.6% in September, a further increase. The Federal Reserve pays special attention to the core inflation rate because it helps illustrate how ubiquitous and persistent inflation has grown throughout the economy.
2. How are Social Security payouts inflation-adjusted?
After President Richard Nixon signed the 1972 Social Security reforms into law, automatic changes to Social Security income started to be made in 1975.
Prior to 1975, Congress had to take annual action to raise benefits in order to counteract the impact of inflation. However, this method was ineffective since politics would frequently be inserted into a straightforward economic choice. A benefit increase might be too modest, too high, or not occur at all under this arrangement if one side completely opposed the change.
Not to mention that placing Social Security on autopilot lessened the political risk that legislators had to take on because it was already obvious that the program would suffer long-term financial challenges in the future when baby boomers—those born between 1946 and 1964—entered the labor market.
Since that time, benefits have increased based on the average increase in consumer prices from the third quarter of a given year to the third quarter of the previous year. This has been increasing somewhat more quickly than the rate of inflation as a whole and is based on a variant of the consumer price index designed to assess price increases for working people.
These inflation adjustments are imprecise and retroactive, while being useful. For instance, 2022 Social Security payouts grew by 5.9% over the prior year, despite the fact that inflation has been much higher overall this year, indicating that the higher benefits weren’t sufficient to offset the increasing cost of living. As a result, the 2023 benefit increase mostly makes up for the loss from the prior year.
3. Do the advantages attract taxes?
With variable thresholds, limitations, and percentages, a rising part of Social Security payments are taxed similarly to regular income. In 1984, just 8% of benefits were taxed; however, in subsequent years, that number has increased to approximately 50%. The taxable levels are not updated for inflation, thus that proportion will probably keep rising.
For instance, if an individual filer’s total income, perks included, is less than US$25,000, then none of it is taxed. However, at wages between $25,000 and $34,000, a person’s benefits might be taxed by up to 50%. After then, taxes might be applied to up to 85% of their benefits.
Given the size of the rise in Social Security payments, it is possible that some individuals who previously paid no taxes will suddenly be required to do so, while their tax obligations may climb significantly for others.
4. What is the purpose of government benefit inflation adjustments?
Rapid increases in inflation, like those that are now occurring in the U.S. and many other nations, can have a big impact on both family and company budgets.
For instance, it can entail elders making food or heating budget cuts. In order to lessen the negative effects that rising prices might have on individuals with fixed or restricted means, government programs typically attempt to take this into consideration.
Additionally, lessening the effects of price fluctuations leads to a more equitable and efficient distribution of resources and fewer arbitrary results than would otherwise be the case.
5. Which other federal programs receive a COLA?
To accommodate for inflation, other government programs and benefits are also raised.
Every year in October, the U.S. Department of Agriculture (USDA) updates the Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps, benefits. It estimates the cost of its Thrifty Food Plan in June. Benefits for food stamps increased by 12.5% starting in October 2022, helping to offset the biggest increases in food costs since the 1970s.
A variety of government-provided benefits, including housing assistance, health insurance, and others, including SNAP payments, are also affected by the Department of Health and Human Services’ yearly adjustment of the federal poverty threshold for changes in the consumer price index.
6. Does the tax system take inflation into account?
Although certain parts of the tax system take inflation into account, others do not.
For instance, the standard deduction amount, the limits of the alternative minimum tax, and the estate tax provisions all rise yearly to account for inflation. Therefore, significant changes in all of these areas are anticipated to be seen to US tax filers during the upcoming tax filing season.
The maximum child tax credit amount and the $10,000 restriction on the deduction of state and local taxes are two examples of provisions that are not modified for inflation. Additionally, because the income threshold that determines who is subject to the extra 3.8% tax on investment and passive income for taxpayers above a particular level doesn’t change, more people are affected each year.