A cost-of-living adjustment (COLA) is an increase in salary or annuity usually based on an objective measure that estimates how much additional money a typical person or household needs to maintain their standard of living.
Inflation acts against the buying power of every dollar. The prices for goods and services increase over time, so a stable income devalues over time. A COLA works against inflation to maintain the salary or annuity’s buying power.
How COLAs Are Used and Determined
A COLA is almost always uniformly applied across an organization or population of recipients. Notable exceptions would be companies with workers spread across the U.S. or around the world. In those cases, a company might consider COLAs that vary by geographic region.
COLAs that are not based on an objective measure are often either inadequate to maintain buying power or unnecessarily high.
The most common objective measure used to determine the amount of a COLA is the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The Social Security Administration is required by law to use the CPI-W to calculate the annual COLAs to Social Security recipients. The CPI-W is calculated by the U.S. Department of Labor's Bureau of Labor Statistics.
U.S. Government COLAs
COLAs for federal workers must be authorized by law. COLAs for civilian employees and military employees are considered separately by Congress. When one of these two groups receives a COLA, the other group immediately begins lobbying Congress to provide the same COLA for them. At times, the COLAs are not the same for both groups, and this can lead to widespread employee dissatisfaction. COLAs may also be given to federal retirees under the Federal Employees Retirement System or Civil Service Retirement System.
Businesses in the U.S. are not required to provide their workers with COLAs. Sometimes union contracts have COLAs built into them. Union leaders push for absolute numbers in negotiations, so they have guaranteed wage increases, while managers may try to link a COLA to some measure of inflation.