Impact of Inflation on Social Security - Term Paper Example

?Impact of Inflation on Social Security Social Security is the comprehensive federal program that provides workers and their dependents with, among other incomes, retirement income and disability income. Social Security on a national level was conspicuous by its absence in the United States until President Franklin Delano Roosevelt signed the Social Security Act in 1935. Two social insurance programs; a federal-state program of unemployment compensation and a federal program of old-age retirement insurance, constituted the original Social Security Act. The Act was amended in 1956 to provide disability benefits also. At present Social Security consists of four separate trust funds; the Old Age and Survivors Insurance (OASI) Trust Fund, the Disability Insurance (DI) Trust Fund, the Hospital Insurance (HI) Trust Fund, and the Supplementary Medical Insurance (SMI) Trust Fund. The fund raising mechanism of Social Security makes it a ‘pay-as-you-go’ system and can be termed as advance-funded. In simple words, funds to this program are contributed by the people who are presently working and are utilized for the benefit of the retirees. Ohlemacher (2010) states that Social Security is funded by a 6.2 percent payroll tax, paid by workers as well as employers. The Social Security corpus is being constantly used and is being replenished at the same time. Since inception, the Social Security program has done exceedingly well and has helped the country tide over many difficult situations. Till date, it remains one of the most successful and most popular programs in the United States which has touched the lives of millions of Americans. Vernon (2011) reveals that as of January 1, 2011, the Social Security trust fund stood at $2.6 trillion. At the end of 2010, close to 54 million people were beneficiaries of this program, while another 157 million people had earnings covered by Social Security and paid payroll taxes. The outflow (expenditures) of the scheme stood at $713 billion while the total inflow (income) was $781 billion in 2010. Of this $664 billion was non-interest income while $117 billion was generated by way of interest. Inflation and Cost of Living Allowances There have been annual increases in Social Security benefits which try and counterbalance the adverse effects of inflation on fixed benefits. This indexing of Social Security benefits for inflation is of monumental importance because the absence of such indexing would result in the erosion of the purchasing power of the beneficiaries. Prices tend to rise over time and increase the cost of living. In such a scenario the beneficiaries would be able to purchase fewer goods and services unless the benefits rise in line with inflation. Known as Cost of Living Allowances (COLAs), these increases in Social Security benefits, based on the annual increase in consumer prices, have become an automatic annual feature of the program beginning 1975. Prior to that, such increases were accorded to the beneficiaries only when the Congress enacted a special legislation. The COLA adjustment is based on the change in the Consumer Price Index for Urban Wage Earners and Clerical Work­ers (CPI-W) over the last year. In periods of deflation where the CPI-W does not increase, no COLAs are announced. Change in Formula Recent reform proposals have called for changes in Social Security’s cost-of-living adjustment (COLA) formula. It has been proposed that a new ‘chained CPI’ be used instead of ‘CPI-W’ that is being used at present. The chained CPI would take into account ‘substitution purchases’ that consumers make to avoid high prices. Estimates reveal that the beneficiaries of Social Security would have to contend with smaller increases under the modified, chained CPI. Estimates reveal that the revised formula would result in a retiree receiving $560 less as benefits per year in the first decade. This loss in benefits would reach $984 in two decades from now. There is a section of the society that avers that the government should adopt an elderly-specific price index such as the Experimental Consumer Price Index. This index, referred to as the Consumer Price Index for the Elderly (CPI-E) would specifically be designed for Americans 62 Years of Age and Older. The CPI-E incorporates the increased utilization of medical care that the elderly purportedly use more than the overall population. If adopted, this index would have the maximum potency to erase the negative repercussions of inflation on Social Security benefits. According to the latest COLA announcement based on the CPI-W formula, more than 60 million Americans will get a 3.6 percent increase in their monthly Social Security and Supplemental Security Income (SSI) benefits in 2012. It is pertinent to mention here that there were no COLA adjustments in 2010 and 2011; the reason being that the CPI-W in these years did not go beyond the level of the third quarter CPI-W of 2008, the year in which the last COLA adjustment had been made. On paper, people depending on Social Security payments are not adversely affected by inflation as the program is indexed for inflation. In fact, keeping pace with inflation is one of the unique attributes of the Social Security scheme. The question however is if the increase in social security benefits is sufficient. Miller (2011) points out that a major area of expense and risk in retirement is health care. The costs of health care rise by as much as four times as compared to the overall inflation. Thus any expenses incurred towards healthcare are bound to dig a big hole in the pocket. Munnell (2008) avers that high inflation raises two important issues that diminish the impact of COLA and has a negative impact on social security benefits. These issues pertain to the Medicare Part B premiums and taxation under the personal income tax. Impact of Medicare Part B Premiums Medicare Part B premiums, which cover physician and out­patient services, are automatically deducted from monthly Social Security payments. If the premiums rise more than the increase accorded by the COLA, the net benefit is negative for the beneficiary. Miller (2011) suggests that the rise in Part B premium at a rate greater than general inflation is due to medical inflation. Here, the “hold harmless” provision, which aims at preventing Social Security payments from ever falling, comes into play. This provision does not allow the Medicare premiums to rise by a greater amount than the Social Security COLA in any given year. The average annual increase for the Part B premium over the last 3 decades has been 9 percent. In comparison, the average annual increase in the Social Security COLA has been merely 3.8 percent. The net effect of these two elements can be best understood with the help of an example. A beneficiary of Social Security is eligible to get $1000. A sum of $100 is deducted automatically from the benefit on account of Medicare Part B premium. Thus the beneficiary gets a net benefit of $900. Now, if we increase the gross benefit and Medicare Part B premium at the average rate of increase in COLA and Part B premium in the last 30 years, the net benefit comes to $929 ($1038-$109). The calculation demonstrates how the automatic increase in Medicare Part B premium partially offsets the COLA gains. The Medicare Part B premiums, also known as the Income Related Monthly Adjustment Amount (IRMAA), for 2012 have not been announced as yet. Ohlemacher (2010) avers that estimates provided by the trustees who oversee the programs, the hike in these premiums could erode as much as 25 percent of the raise from Social Security. Panko (2005) suggests that the retirement of the boomer generation will, in itself, be an inflationary factor. These retirements are likely to put strain on the nation's health-care infrastructure. The higher demand, unmatched by a parallel increase in the supply of health-care services will raise prices and the burden on the pocket. Thomasson (2011) avers that Part B premiums cover 25 percent of the program costs. Since for the last two years, the Medicare premiums had been frozen, maximum burden fell on new enrollees and high income families. Medicaid, the federal/state program for the poor, which pays the premiums for low income families, also had its share of financial burden. Impact of Taxes According to the Internal Revenue Service (IRS) rules no beneficiary pays federal income tax on more than 85 percent of Social Security benefits. In cases where people have substantial other income like wages, interest, dividends etc. in addition to the Social Security benefits, it attracts tax as per the provisions of the federal personal tax rules. Under the current slabs of taxation, individuals with less than $25,000 of income and married couples with less than $32,000 of joint income are exempt from taxes on their Social Security benefits. Over and above these threshold limits, the beneficiaries have to pay taxes on as much as 85 percent of their benefits. Moreover, taxes are levied without adjusting for inflation. Rising benefit levels entails that people lower down the income distribution also fall under the tax slabs and thus, going forward, a considerably higher percentage of Social Security benefit recipients will be subject to taxes. Conclusion There is no doubt in the fact that Social Security is an extremely valuable source of money inflow for the retirees. Although the inherent nature of the Social Security, through COLAs, indexes it for inflation, the latter still has erosive impact on Social Security benefits. Broadly speaking, inflation has an adverse bearing on the Social Security benefits because of the Medicare Part B premium payments and the federal personal income tax system. At present the COLA adjustments are based on the change in the CPI-W. In case the chained CPI formula is adopted, the resultant COLAs would be of a smaller magnitude than what is declared under the present mechanism of CPI-W. This will further reduce the purchasing power of the retirees. The adverse corrosive impact of inflation on Social Security benefits is indeed a grave concern for the retirees who are practically left with no source of infla­tion proof source of income. References Centre for Retirement Research. (2008). The Impact of Inflation on Social Security Benefits. Boston: Munnell, Alicia, H. Muldoon, Dan. Miller, Mark. (2011, Mar 23). 4 Ways to Add Inflation Protection to your Retirement Plan. Retrieved from http://blogs.reuters.com/reuters-money/tag/inflation/page/2/ Ohlemacher, S. (2010, Oct 15). Gov't: No increase for social security next year. Spartanburg Herald - Journal, pp. n/a. Retrieved from http://search.proquest.com/docview/758862683?accountid=133056 Panko, R. (2005). Security gap. Best's Review, 106(6), 86-86-90. Retrieved from http://search.proquest.com/docview/205472503?accountid=133056 Social security trust funds to be exhausted in 2040, say estimates. (2006). Pension Benefits, 15(7), 4-4,6. Retrieved from http://search.proquest.com/docview/205118841?accountid=133056 Tieman, J. (2004). Who's to blame? Modern Healthcare, 34(37), 8-8-9. Retrieved from http://search.proquest.com/docview/211961698?accountid=133056 Thomasson, Dan K. (2011, Oct 25). Social Security Boost Not Real. Retriveed from http://detnews.com/article/20111025/OPINION01/110250320/Social-Security-boost-not-real#ixzz1bs2wWbQt Vernon, Steve. (2011, Aug 15). How to Fix Social Security’s Financing Problem. Retrieved from http://moneywatch.bnet.com/retirement-planning/blog/money-life/how-to-fix-social-securitys-financing-problem/4904/#ixzz1bVRjhEcv Read More