When discussions about whether a pension should include a cost-of-living adjustment come up, the arguments often focus on what is "fair." That argument has force: the high inflation rates of the 1970s taught U.S. workers a tough lesson: if you retire on a fixed nominal income, inflation will nibble or gobble away at its purchasing power. Thus, Social Security benefits began to receive an automatic cost-of-living adjustment in 1975. Today, almost all state and local government pensions have some form of built-in cost-of-living adjustments, too.
But making a promise about future payments is, ultimately, all about what you are able and willing to pay when the bills come due. In an otherwise completely forgettable song about 20 years ago, a group called Stetsasonic sang: "[J]ust like my mother used to say in the past/ Don't let your mouth write a check that your ass can't cash." A lot of state and local pension funds let their mouths write checks that they are no longer willing to cash. At some point, Social Security may make a similar decision.
The National Association of State Retirement Administrators last month put out a "NASRA Issue Brief: Cost of Living Adjustments," which tallies how many states have been backing away from their COLA promises for retirees. The report states: "It has been estimated that an automatic COLA of one‐half of an assumed CPI of three percent, compounded, will add 11 percent to the cost of the retirement benefit. An automatic COLA of three percent, compounded, will add 26 percent to the cost of the benefit." Here's a map showing states that made changes in their COLA arrangements for retirees from 2009-2011 (although some of these changes are being challenged in court): states in white haven't made changes; in orange, changes affecting current retirees; in green, changes affecting new hires only; and in blue, changes affecting both new hires and current retirees.
Here are some examples of how the COLA adjustments are happening: A number of states have COLAs that are not linked to inflation, but instead are just an automatic percentage amount each year. Some states (Colorado, Hawaii) have reduced the promised annual percentage increase. Other states have gone further and sought to eliminate any automatic COLA increases at all, while of course still leaving open the possibility that legislatures could increase pensions on an ad hoc basis in the future (Kansas, Washington, and Florida). Still other states have set up rules that the full COLA, or any COLA, would only be paid if the pension fund achieves either a certain annual return (Massachusetts) or achieves a certain level of funding (Minnesota, New Jersey, Oklahoma). Still other states have set a cap on either how much income the COLA will apply to (Maine) or a cap on how much the COLA can increase salary over the lifetime of a retiree (Nevada, Missouri). A number of states have tried several of these ideas.
How likely are we to see similar changes as a way of addressing the problem of Social Security?
The Social Security actuaries estimate that if the COLA for Social Security was adjusted to be the rate of inflation minus 1 percentage point each year--instead of the full rate of inflation--that change alone would solve nearly three-quarters of the projected gap over the next 75 years between expected revenues and promised benefits.
I don't expect that politicians will do anything that transparent to Social Security. But as part of a package of changes to assure that Social Security is funded in a way that it can cover its promises over the next 75 years, I wouldn't be at all surprised to see less-transparent changes in benefit formulas that have the effect of reducing COLA adjustments.
As I noted at the start, there is a fairness argument that adjusting COLAs is unfair. But what is also unfair is for past legislatures and for Congress to set up pension and retirement programs, make promises about benefit and then fail to finance those programs sufficiently, and hand off the whole mess to future taxpayers and future retirees. The real blame in the pension and Social Security messes shouldn't go to those who are trying to address the problem, but to those who created it.