The good news first: inflation has remained low for 2013. The latest annual inflation rate for the United States is 1.2%, as reported by the Bureau of Labor Statistics (BLS) on September 17, 2013 (there was no October 16 inflation rate release due to the shutdown). In fact, over the past year, inflation never rose above 2%.

But that also brings some bad news for some: Social Security benefits will only step up by 1.5% in 2014. That increase marks one of the smallest increases in the history of Social Security’s annual cost-of-living adjustment. By comparison, increases were 1.7% for 2013 and 3.6% for 2012.

How do the increases for payouts compare to contributions? For workers still paying into the system, the contribution base for Social Security is expected to increase by nearly 3%. The base is the amount of wages used to calculate contributions to the system (the same limits apply for purposes of figuring benefits). The amount of tax paid on the base amount is set by statute at 6.2%: that amount is paid by the employee and matched by the employer for a total amount of 12.4%.

(That extra you see in FICA withholding is attributable to Medicare tax of 1.45% for employees and employers for a total of 2.9%. There is no cap on wages for purposes of Medicare tax.)

For 2014, the base is $117,000 as compared to $113,700 for 2013. According to the Social Security Administration, that will result in about 6% of workers paying more in taxes (by the numbers, it works out to about 10 million workers).

Benefit payouts which are based on the cost-of-living – like Social Security – are measured by the consumer price index (CPI). The CPI is published by the Bureau of Labor Statistics and reflects “changes in the prices paid by urban consumers for a representative basket of goods and services.” Whether that is an accurate measurement for purposes of calculating benefits has been a point of discussion for a number of years.

Concerns about increases – and how to measure them – have revived calls to consider an alternative version defining inflation as determined by the Consumer Price Index (CPI). The one that has received the most attention is the “chained” CPI. The appeal of the “chained” CPI is that it measures consumer responses to higher prices rather than simply measuring the higher prices. Here’s an example of the two are calculated:

Let’s say that in 2012, coffee was $10/pound and tea was $10/pound. And because I tend to drink more coffee, I bought 10 pounds of coffee and 2 pounds of tea. In 2013, let’s say that coffee jumped to $15/pound and tea went up to a mere $11/pound. Even though I love coffee, let’s say I switched to tea because it was cheaper (again, this is just a hypothetical – I am not, I repeat, not changing my coffee consumption) and bought 5 pounds of coffee and 7 pounds of tea. I still bought 12 pounds of caffeinated beverages but I altered the proportions because of the pricing. The theory is that most folks react in a similar manner – you alter your spending to compensate for increases.

Here’s how the “normal” CPI calculations based solely on price increases would look:

(10 x 15) + (2 x 11)/(10 x 10) + (2 x 10) = 1.4333

But the “chained” CPI calculations which reflect the change in my behavior would look like this:

(5 x 15) + (7 x 11)/ (10 x 10) + (2 x 10) = 1.267

In my examples, the “chained” CPI results in a lower number – that tends to be the pattern. While that means a lower payout for benefits – like Social Security – over time, it’s considered by many to be a more accurate capture of spending power. Lower payouts, while politically unpopular, would result in reduced pressure on the budget.
It’s not surprising, then, that the GOP suggested the proposal last year as budget talks heated up. Sen. Harry Reid (D-NV) referred to the switch as a “non-starter” though President Obama has expressed a willingness to consider it.

Social Security benefits are a huge payout for the government, even taking into consideration contributions. For September 2013, 57,695,000 recipients (including survivor and disability benefits as well as retirement benefits) cashed $67,053,000,000 in benefit checks (for an average monthly payout of $1,162.20). Annualized, that works out to $804,636,000,000. That’s a lot of zeroes. With those kinds of dollars at play, expect Social Security benefits and contributions to be a major factor in future budget talks.

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Kelly Erb is a tax attorney, tax writer and podcaster.

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