It is the most important time of the year for the 64 million beneficiaries of social security
Since 1975, the consumer price index for urban and office workers (CPI-W) has served as an inflationary link to social security. The CPI-W measures price changes for a large basket of goods and services.
To determine the annual adjustment of the cost of living (COLA) of Social Security, only the readings of the third quarter (from July to September) are taken into account. Thus, the average CPI-W reading for the third quarter of the current year is compared to the average CPI-W reading for the third quarter of the previous year. If this number increases from year to year (which means inflation), Social Security beneficiaries will receive an increase proportional to the percentage increase and rounded to the nearest tenth of a percent.
In 42 of the past 45 years, Social Security recipients have received a “raise” to help them keep up with inflation.
But that was not the case in 2010, 2011 or 2016. In the case where the CPI-W shows that prices have fallen from year to year (ie deflation), the social security COLA is 0%. For the most part, profits remain static year over year. Fortunately, monthly benefits cannot decrease due to deflation.
With July now on the books, there are two months left that count towards determining Social Security’s COLA for 2021. However, it is not promising for beneficiaries to see an increase in their payments in January.
According to June inflation data from the U.S. Bureau of Labor Statistics, the CPI-W has only increased 0.5% in the past 12 months. The somewhat similar Consumer Price Index for all urban consumers (CPI-U) shows a double-digit percentage drop for everything energy-related over the past 12 months, which has declined significantly in transportation services, clothing, and used cars and trucks. While it is possible that COLA will be positive for 2021, it seems likely that next year will be the fourth time in 46 years that recipients have not received COLA.
No COLA in 2021 would be great news for high-income earners
However, COLA’s determination of Social Security affects more than what its 64 million and more beneficiaries bring home each month. The point is that a 0% COLA could blow high-income earners for joy.
In a typical year, the National Average Wage Index (NAWI) – a measure of wage trends in the United States used by the Social Security Administration – will increase. The year-over-year percentage increase of the NAWI is what is used to determine the annual increase in the maximum taxable earnings cap associated with the 12.4% payroll tax on earned income.
For example, the 2018 ANWI was 3.6% higher than the previous year. As a result, the maximum taxable income limit has increased from $ 132,900 last year to $ 137,700 in 2020. This increase of $ 4,800 represents an increase in (drum roll) of 3.6%.
But there is an interesting Social Security rule that comes into play when the program’s COLA is 0%. In years of deflation, the maximum cap on taxable profits remains unchanged from year to year. This is true even if the NAWI is positive – and according to the projections of the Social Security Administration, the ANWI should increase by 3.1% for the calculation of the coming year.
In other words, 94% of American workers will not earn $ 137,700 in 2020, and therefore pay Social Security, through payroll tax, for every dollar they earn. It is the remaining 6% who earn more than $ 137,700 who are required to pay more each year when the ANWI causes an increase in the payroll tax cap. But if there is no COLA in 2021, there will also be no increase in the social security contribution ceiling. This means that the rich will be able to keep more of their earned income, at least for a year.
Why doesn’t social security tax the rich more?
You are probably now wondering why this loophole exists in the first place. In essence, why are the better-off not taxed more to strengthen the social security program?
The answer to this question lies in another social security rule.
You see, there is a maximum allowable monthly payment at full retirement age ($ 3,011 in 2020). While this maximum payment is often adjusted on an annual basis, the point is that the maximum taxable earnings cap exists because there is also a cap on how much a retired worker can receive each month. It does not make sense to tax millions of dollars in earned income if the maximum an individual can expect to receive is $ 3,011 per month from Social Security.
Moreover, although the American public supports increased taxation of high incomes, it is not easy to change the law on social security. It requires 60 votes in the Senate, and there has not been a true supermajority for over 40 years. Changing the social security law would require bipartisan support; and Republican lawmakers have already voiced their objection to raising taxes on the wealthy to generate additional income.
While 2021 could be another bad year for Social Security recipients due to the loss of purchasing power, it could be a great year for high-income workers.