Publisher's Perspective

For years, much of the focus in Washington on federal retirement benefits has centered around two main assertions.

First, that the cost of living adjustment, or COLA, provisions are very valuable.

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Second, that we must do something about that.

As to the first point, there is no doubt that inflation protection is a valuable annuity benefit. That’s why it’s built into so many benefit programs in the first place, including Social Security and military retirement, along with civil service retirement.

For those under the CSRS system—still the majority of retirees, although not only a small minority in the active workforce—there is full inflation protection that parallels the calculation used in Social Security, paid regardless of age at retirement.

For those under the FERS system, COLAs generally aren’t paid to retirees until age 62, unless disabled or subject to mandatory retirement. And when COLA are paid, they match the CSRS/Social Security figure only if the number is 2 percent or below; they are capped at 2 percent if that number is between 2 and 3, and are 1 percentage point less if it is above 3 percent.

As to the second point, there is also no doubt that even the less generous FERS formula compares well with what most private sector employees get during retirement these days—if they get an employer-sponsored annuity at all.

Whether something needs to be done about it, and if so what, is another issue.

On the one side there have been repeated proposals from Republicans in Congress, and during this administration from the White House, to reduce the value of COLAs. Those proposals have taken many forms but the most recent has been to cut the CSRS amount in half, while eliminating the FERS civil service portion entirely (although FERS retirees would continue to get the full COLA on the Social Security portion of their annuities).

There is, to be sure, a fiscal argument behind those proposals: because COLAs are valuable to those who receive them they are expensive to those who provide them, in this case the federal government which annually runs deficits.

The counter to that argument has been that it just amounts to a race to the bottom, and that the proper course of action is to boost what private sector retirees get to match federal benefits, not the other way around.

Alternatively, there have been proposals from many of the same sources to use an inflation measure that they argue is more accurate, one that takes into account the fact that consumers do not continue to buy the same mix of goods regardless of price changes, as the standard Consumer Price Index measure assumes. Specifically, the argument is that as the price of one of two interchangeable things increases but the price of the second doesn’t—or increases by less—people will buy more of the latter and less of the former.

The counter to that argument is that the current measure should be replaced with one that better measures the living costs of retirees. Those costs in many ways differ from the living costs of those who are still employed, this argument goes, and in many ways are higher, for example for health care and long-term care.

Those are not theoretical data sets; the Labor Department has produced both alternative measures for years: in the former case since 1978 the “chained” CPI, and in the latter since 1988 the “CPI-E,” the E standing for elderly (starting at 62, an age that few call elderly anymore). However, that has been mainly for academic purposes, since the government continues to use the traditional CPI for adjusting federal retirement and most other inflation-indexed programs.

At first glance, changing to one of the alternatives may not seem to make much difference—the chained CPI on average shows annual increases on the order of a quarter of a percentage point below the standard CPI, while the CPI-E on average shows about the same difference above it.

But “even a fraction of a percent difference in the index used to adjust retirement benefits can accumulate over time, resulting in tangible monthly differences for individual beneficiaries” due to the effects of compound inflation over period of receiving benefits that can last two, three or four decades, the Government Accountability Office said in a recent report.

Further, “As Americans’ life expectancy continues to increase, more retirees are exposed to the effects of COLAs over longer periods.”

However, the GAO declined to act as a tie-breaker by recommending a change to one or the other of the alternatives. The Bureau of Labor Statistics has difficulties with all of the options, it said, for example with uncertainty regarding what a subpopulation such as retirees pay, where they shop, and what they purchase.

Nor is there much to be learned from the experience in other countries, it added. “Some countries have changed to an alternate index to reduce benefits and improve the financial sustainability of their pension systems, while others have changed to increase the purchasing power of pension benefits.” However, nearly all of the 36 major developed countries it studied simply use their basic inflation measure for adjusting retirement benefits.

That’s what the U.S. does today, and the GAO found no strong reason to do anything different, saying that the first issue for attention should be on ways to improve all the measures.

The arguments will go on, but there is a risk of the Pandora’s Box effect. Once you open the topic for active review, you can’t tell what might come out. Possibly that would even be a decision to make those proposed cutbacks in CSRS and FERS inflation protection, since advocates would no doubt use any formal review to call attention to the how those programs compare favorably to the private sector’s.

Federal retirement COLA policies have been changed over time although not for many years. They may be an anachronism, but that anachronism that has served federal retirees—and federal employees projecting that one day they will become retirees—very well over the years. This may be a case where it’s best to leave well enough alone.

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