By Sharon McKnight, CCP, SPHR, BLR Senior Editor
I can remember when a candy bar cost a nickel. Now, it’s a challenge to find one under a dollar. The cost of placating my sweet tooth, however, didn’t just leap from five cents to nearly a hundred pennies all at once. It crept up in itty-bitty steps each month, which accumulated into short strides each year. In a nutshell, those small increments are the CPI.
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The Consumer Price Index (CPI), as defined by the Bureau of Labor Statistics (BLS), is a measure of the average change over time in prices paid by urban consumers for a “market basket” of goods and services. For example, if an average family had to spend $50 for groceries in 1988 and $150 for those same groceries in 1998, the CPI would have tripled in 10 years. BLS measures changes in these costs from year to year and reports on them in the form of two Consumer Price Indexes, the CPI-W and the CPI-U.
The CPI-W is the older index. It covers only urban wage earners and clerical workers and represents about 32% of the U.S. population.
The CPI for Urban Consumers (CPI-U) is the newer, broader index. It began in 1978 and represents the buying habits of about 87% of the U.S. population. BLS bases the CPI-U on the expenditures of residents of urban or metropolitan areas, including: professionals; professional, managerial, and technical workers; the self-employed; the poor; short-term workers; the unemployed; and retired persons, as well as urban wageworkers and clerical workers.
The CPI “market basket” is developed from detailed expenditure information provided by families and individuals on what they actually bought. This information is collected from Consumer Expenditure Surveys that survey thousands of families from around the country to gather information from each quarter on their spending habits.
To collect information on frequently purchased items, such as food and personal care products, another set of thousands of families in each of these years keep diaries listing everything they bought during a 2-week period. In general, CPI refers to CPI-U data.
How to obtain CPI data—and why it’s important to employers
BLS issues national data, with the figures released around the 26th of each month and widely reported in the media at that time. The latest available CPI figures and percent of increase in the index can be found in the Merit Increase Resource Center at Compensation.BLR.com®. For additional information on CPI statistics, see the national Consumer Price Index section on the BLS website.
Many employers monitor the CPI closely because wages tend to follow changes in the cost of goods. Rather than, or in some cases in addition to, providing performance-based merit increases, employers may provide cost of living adjustment (COLA) increases, which are also referred to as general increases. Some employers use the most recent annual CPI as the percent of increase for their COLA and some simply pay what they can afford.
Either way, the ratio of employers offering merit increases to those offering general increases is rising. BLR’s recent surveys show that 18% more employers offered merit increases than COLAs in 2013 and that, in 2016, 46% more offered increases tied to performance.
Given many employers use of the annual CPI as their COLA, it’s easy to think that CPI and COLA are the same, but they’re a bit like fraternal twins—same origin with slight differences. For example, COLA, as calculated by many employers, uses the CPI-U but, as calculated by the government, uses CPI-W.
Social Security COLA
Legislation enacted in 1973 provides for cost-of-living adjustments, or COLAs for Social Security and Supplemental Security Income (SSI) benefits to keep pace with inflation. Since 1975, Social Security general benefit increases have been cost-of-living adjustments or COLAs. Prior to 1975, Social Security benefit increases were set by legislation.
The first COLA was based on the increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the second quarter of 1974 to the first quarter of 1975. The 1976-83 COLAs were based on increases in the CPI-W from the first quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective.
After 1983, COLAs have been based on increases in the CPI-W from the third quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective.
A COLA increases a person’s Social Security retirement benefit by approximately the product of the COLA and the benefit amount. The exact computation, however, is more complex. Each Social Security benefit is based on a “primary insurance amount,” or PIA. The PIA is directly related to the retiree’s earnings through a benefit formula.
It is the PIA that is increased by the COLA. For example: if the initial PIA is $1,393.50 and it is increased by a 1.7% COLA, the new PIA would be $1,417.10, after rounding to the next lower dime.
Specific information on how the Social Security Administration uses the CPI to determine cost-of-living adjustments can be found here.
The difference between CPI and COLA
If looking strictly at the numbers, they are often the same, implying that there isn’t much difference—but their definitions belie that. CPI is the year-to-year change in the cost of a select market basket of goods and services. COLA is the year-to-year change in the amount of a retiree’s Social Security benefit or an employee’s pay (not tied to job performance) tied to the most recent CPI.
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Sharon L. McKnight, CCP, SPHR, draws from more than 20 years of management experience, including 6 years as a director of human resources, to develop compensation administration tools and write about compensation issues. Her experience in both operational and HR management provides her with a practical approach to providing online resources that address the challenges facing compensation and human resource professionals.