Cost-of-living adjustments (COLAs) for Social Security beneficiaries are a frequent target for reform. Last February, Federal Reserve Board Chairman Alan Greenspan recommended cutting retirement benefits by reducing COLAs (Greenspan 2004).1 He argued that these inflation adjustments are overly generous because they are based on the change in the consumer price index (CPI), which most experts agree overstates the true increase in the cost of living. Although this reform would save Social Security money, it would also create financial problems for some retirees, especially those at advanced ages who have been receiving Social Security benefits for many years. Some even argue that COLAs are not generous enough because many older Americans spend heavily on health care, which has been rising more rapidly in cost in recent years than most goods and services.

Nearly everyone agrees that some change to Social Security is necessary, as the growing size of the older population threatens to bankrupt the system. Projections estimate only 27 working-age adults (age 20 to 64) for every 10 senior citizens (age 65 and older) in 2040, down from 48 working-age adults in 2000 (Board of Trustees, Federal Old-Age Insurance 2004). This growing imbalance means fewer workers to pay taxes to finance retiree benefits.

This brief examines the consequences of potential Social Security COLA reforms on the incomes of older Americans. Because the effects of COLA changes accumulate during retirement, the full impact of any reform implemented now would not be felt for many years. As a result, we project individual financial outcomes in 2040, by which time even the oldest beneficiaries would have spent virtually all of their retirement years under the reformed COLA rules. We model the potential impact on median Social Security benefits and the share of older adults with limited incomes. We also examine how the outcomes would vary by economic status.

The results show that cutting Social Security COLAs along the lines suggested by Greenspan would substantially reduce family incomes for the oldest and most vulnerable retirees. For adults age 85 and older, median Social Security benefits would be 13 percent lower in 2040 after the COLA cuts than they would be under current rules. The impact would be much smaller for relatively young beneficiaries, who already receive more Social Security income than older beneficiaries because benefits are based on career earnings. COLA cuts would prove especially painful for those with limited incomes, and would push millions of older adults onto the bottom rungs of the income distribution.