This
week, Advisor Perspectives published my article entitled, “Social Security’s Short‑Term Crisis: What Advisor’s Must Prepare For.” The
primary purpose of this article was to focus on possible solutions to
the system’s short-term financing problems, not its long-term financial
problems. One of the alternative solutions discussed in the article
involved freezing cost‑of‑living increases (COLAs) for several years.
While a temporary freeze is an efficient short‑term lever, it is also
regressive and politically difficult. An alternative approach is to modify the COLA formula itself in a way that protects lower‑benefit retirees while moderating both short-term and potential long-term cost growth.This post outlines a progressive COLA‑cap mechanism that accomplishes those goals. Concept: A Progressive COLA CapUnder
current law, COLAs are proportional to benefit size: every retiree
receives the same percentage increase, so higher‑benefit retirees
receive larger dollar increases. This structure is not inherently
progressive.A progressive alternative is:COLA = the lesser of (CPI increase) or $X, but not less than Y% of the CPI increase.This creates a dollar cap
on the annual COLA. Low‑benefit retirees would typically receive full
CPI, while higher‑benefit retirees receive a smaller percentage
increase. Annual Redetermination of To avoid arbitrary or outdated caps, can be recalculated each year:where is the average retired‑worker benefit in the prior year or some percentage of the average benefit.This ensures:Automatic scaling as benefits grow.Built‑in progressivity: retirees below the average benefit rarely hit the cap.Predictable savings tied to the benefit distribution. Determination of YY
determines the floor percentage increase applicable to beneficiaries
with relatively higher benefit levels. This rate would be a lower
percentage of the full COLA rate or even start at zero and gradually
increase over the years depending on how much is needed to help solve
the system’s short-term funding problem. Addressing Fairness for Early/Late ClaimersA
potential fairness issue arises with this general proposal because
delayed claimers have higher benefits due to actuarially fair delayed
retirement credits. Under a simple dollar cap, they are more likely to
be constrained even though their higher benefit is “earned.”A refinement is to apply the cap test to:where is the early/late retirement factor. This effectively bases the cap on the retiree’s PIA‑equivalent benefit, aligning the cap with lifetime earnings rather than claiming age.This adjustment:Improves actuarial fairness.Removes behavioral distortions related to claiming age.Adds complication to the proposal. ExampleLet’s
assume Congress sets X at 50% of the average monthly benefit (assumed
to be $2,000) for the preceding year and sets Y as 25% of the full COLA.
The following table shows the COLAs for beneficiaries with various
ERF-adjusted benefits assuming the full COLA is 3% under the proposal:ERF-Adjusted Monthly BenefitCOLA$1,000 and below3%$2,0001.5%$3,0001%$4,000 and above0.75% Short-Term or Long-Term Solution?Depending
on the X and Y chosen by Congress and the effective date of
implementation, the proposal may not be as efficient as part of a
short-term solvency patch as a COLA freeze, but it could be more
effective as part of addressing the long-term problem.A progressive COLA cap could directly affect post‑entitlement price indexing, which compounds over decades. The result is a structural flattening of benefit growth, concentrated among higher‑benefit retirees.This makes the proposal well‑suited for inclusion in a comprehensive long‑term solvency package, alongside more modest tax adjustments or benefit formula changes. SummaryA progressive COLA cap:Protects lower‑benefit retirees from inflation erosion.Moderates long‑run benefit growth.Preserves political feasibility better than a COLA freeze.May
provide more modest short‑term savings but offers significant long‑term
compounding savings (depending on provisions adopted), andCan be refined using PIA/ERF adjustments to improve fairness.
A Progressive COLA‑Cap Approach for Strengthening Social Security’s Finances
