How Well Are Social Security Recipients Protected from Inflation?

For men born in 1918 who began receiving benefits at age 65... in 1983, {there was] a decline in real purchasing power of almost 20 percent [by 2007]. Women born in 1918 saw their average Social Security benefit, net of out-of-pocket medical expenses, decline by almost 27 percent.

Social Security, a major source of retirement income for elderly people in the United States, indexes benefits for inflation by using the Consumer Price Index for Urban Wage Earners (CPI-W). In How Well Are Social Security Recipients Protected from Inflation? (NBER Working Paper No. 16212), authors Gopi Shah Goda, John Shoven, and Sita Nataraj Slavov assess the extent to which the indexation of benefits actually protects Social Security beneficiaries against inflation.

For two reasons, indexing benefits by the CPI-W may not keep the purchasing power of Social Security beneficiaries constant as they age. One is that retirees spend a greater share of their income on medical care than workers, and medical care costs tend to grow at a faster rate than the costs of other goods and services. Second, as the authors show using the 1995 through 2006 waves of the Health and Retirement Study (HRS), the share of income spent on medical care tends to increase with age.

In fact, the authors show that protecting the real purchasing power of Social Security benefits, net of out-of-pocket medical costs, for men born in 1918 who began receiving benefits at age 65 would require the amount paid to have risen from $588.63 per month in 1983 to $1,080.90 per month in 2007. The actual benefit was $866.80 per month in 2007, which suggests a decline in real purchasing power of almost 20 percent. Women born in 1918 saw their average Social Security benefit, net of out-of-pocket medical expenses, decline by almost 27 percent.

The authors also investigate how using an experimental price index for the elderly, known as the CPI-E, to index annual Social Security benefits might change the level of protection against inflation. They conclude that indexing benefits with the CPI-E instead of the CPI-W would result in a smaller, but still substantial reduction in real purchasing power for both men and women (11 percent and 18 percent, respectively).

-- Linda Gorman