Cost-of-living index
Encyclopedia
Cost of living is the cost
of maintaining a certain standard of living
. Changes in the cost of living over time are often operationalized in a cost of living index
. Cost of living calculations are also used to compare the cost of maintaining a certain standard of living in different geographic areas. Geographic differences in cost of living can be measured in terms of purchasing power parity
rates.
) can be tied to a cost-of-living index, typically to the Consumer Price Index
(CPI). A Cost of Living Allowance
(COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.
Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally-determined indexes. Most economists and compensation analysts would consider the idea of predetermined future "cost of living increases" to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have actually increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity
, efficiency wages
, and worker bargaining power
rather than simply living costs, and (2) most cost-of-living indexes (see above) are not forward-looking, but instead compare current or historical data.
Cost of living allowance is equal to the nominal interest minus the real interest rate.
The widely recognized problem known as bracket-creep can also occur in countries where the marginal tax brackets themselves are not indexed — COLA increases simply place more dollars into higher tax rate brackets. (Only under a flat-rate tax system would a percentage gain on gross income translate into a comparable inflation-offsetting gain at the after-tax level.)
Some salaries and pensions in the U.S. with a COLA (they vary by type) include:
Pensions in Canada with a COLA include:
adjustment to reflect local market conditions.
A cost-of-living allowance is frequently given to members of the U.S. military
stationed at overseas bases if the area to which a service member is assigned has a higher cost of living than the average area in the United States. For example, service members stationed in Japan
receive a cost of living allowance of between $300 and $700 per month (depending on pay grade
, years of service, and number of dependents), in addition to their base pay. This additional pay is non-taxable.
Specific:
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...
of maintaining a certain standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...
. Changes in the cost of living over time are often operationalized in a cost of living index
Cost of living index
A cost-of-living index is a theoretical price index that measures relative cost of living over time or regions. It is an index that measures differences in the price of goods and services, and allows for substitutions to other items as prices vary....
. Cost of living calculations are also used to compare the cost of maintaining a certain standard of living in different geographic areas. Geographic differences in cost of living can be measured in terms of purchasing power parity
Purchasing power parity
In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...
rates.
Cost-of-living adjustment (COLA)
Employment contracts, pension benefits, and government entitlements (such as Social SecuritySocial Security (United States)
In the United States, Social Security refers to the federal Old-Age, Survivors, and Disability Insurance program.The original Social Security Act and the current version of the Act, as amended encompass several social welfare and social insurance programs...
) can be tied to a cost-of-living index, typically to the Consumer Price Index
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
(CPI). A Cost of Living Allowance
Cost of Living Allowance
Cost of Living Allowance is a United States military entitlement given to military servicemen and women living in high cost areas or stationed overseas...
(COLA) adjusts salaries based on changes in a cost-of-living index. Salaries are typically adjusted annually. They may also be tied to a cost-of-living index that varies by geographic location if the employee moves.
Annual escalation clauses in employment contracts can specify retroactive or future percentage increases in worker pay which are not tied to any index. These negotiated increases in pay are colloquially referred to as cost-of-living adjustments or cost-of-living increases because of their similarity to increases tied to externally-determined indexes. Most economists and compensation analysts would consider the idea of predetermined future "cost of living increases" to be misleading for two reasons: (1) For most recent periods in the industrialized world, average wages have actually increased faster than most calculated cost-of-living indexes, reflecting the influence of rising productivity
Productivity
Productivity is a measure of the efficiency of production. Productivity is a ratio of what is produced to what is required to produce it. Usually this ratio is in the form of an average, expressing the total output divided by the total input...
, efficiency wages
Efficiency wages
In labor economics, the efficiency wage hypothesis argues that wages, at least in some markets, are determined by more than simply supply and demand. Specifically, it points to the incentive for managers to pay their employees more than the market-clearing wage in order to increase their...
, and worker bargaining power
Bargaining power
Bargaining power is a concept related to the relative abilities of parties in a situation to exert influence over each other. If both parties are on an equal footing in a debate, then they will have equal bargaining power, such as in a perfectly competitive market, or between an evenly matched...
rather than simply living costs, and (2) most cost-of-living indexes (see above) are not forward-looking, but instead compare current or historical data.
Cost of living allowance is equal to the nominal interest minus the real interest rate.
CPI is not a COLA
When cost of living adjustments, negotiated wage settlements and budgetary increases exceed CPI, media reports frequently compare the two without consideration of the pertinent tax code. However, CPI is based on the retail pricing of a basket of goods and services. Most purchases of that same basket require the use of after-tax dollars — dollars that were often subject to the highest marginal tax rate. Consequently, the COLA will necessarily have to exceed the CPI/inflation rate to maintain purchasing power.The widely recognized problem known as bracket-creep can also occur in countries where the marginal tax brackets themselves are not indexed — COLA increases simply place more dollars into higher tax rate brackets. (Only under a flat-rate tax system would a percentage gain on gross income translate into a comparable inflation-offsetting gain at the after-tax level.)
Some salaries and pensions in the U.S. with a COLA (they vary by type) include:
- Social SecuritySocial Security (United States)In the United States, Social Security refers to the federal Old-Age, Survivors, and Disability Insurance program.The original Social Security Act and the current version of the Act, as amended encompass several social welfare and social insurance programs...
- Civil Service Retirement SystemCivil Service Retirement SystemThe Civil Service Retirement System organized in 1920 and has provided retirement, disability and survivor benefits for most civilian employees in the US federal government. Upon the creation of a new Federal Employees Retirement System in 1987, those newly hired after that date cannot...
(CSRS) - Federal Employees Retirement SystemFederal Employees Retirement SystemThe Federal Employees Retirement System is the current retirement system for employees within the U.S. federal civilian employees...
(FERS)
Pensions in Canada with a COLA include:
- Canadian Auto Workers union (CAW) Local 200 (Ontario)CAW Local 200CAW Local 200 is a local union of the Canadian Auto Workers union . It represents workers in Windsor, Ontario at three Ford of Canada engine plants, , & the Annex/LVL/3-Valve, and one Nemak aluminum casting plant .- Presidents :# Roy England...
Other uses of the term "cost-of-living allowance"
Stipends or extra pay provided to employees who are being temporarily relocated may also be called cost-of-living adjustments or cost-of-living allowances. Such adjustments are intended to offset changes in welfare due to geographic differences in the cost of living. Such adjustments might more accurately be described as a per diem allowance or tied to a specific item, as with housing allowances. Employees who are being permanently relocated are less likely to receive such allowances, but may receive a base salarySalary
A salary is a form of periodic payment from an employer to an employee, which may be specified in an employment contract. It is contrasted with piece wages, where each job, hour or other unit is paid separately, rather than on a periodic basis....
adjustment to reflect local market conditions.
A cost-of-living allowance is frequently given to members of the U.S. military
Military of the United States
The United States Armed Forces are the military forces of the United States. They consist of the Army, Navy, Marine Corps, Air Force, and Coast Guard.The United States has a strong tradition of civilian control of the military...
stationed at overseas bases if the area to which a service member is assigned has a higher cost of living than the average area in the United States. For example, service members stationed in Japan
United States Forces Japan
The refers to the various divisions of the United States Armed Forces that are stationed in Japan. Under the Treaty of Mutual Cooperation and Security between the United States and Japan, the United States is obliged to defend Japan in close cooperation with the Japan Self-Defense Forces for...
receive a cost of living allowance of between $300 and $700 per month (depending on pay grade
Pay grade
Pay grades are used by the uniformed services of the United States to determine wages and benefits based on the corresponding military rank of a member of the services...
, years of service, and number of dependents), in addition to their base pay. This additional pay is non-taxable.
See also
- ACCRA Cost of Living IndexACCRA Cost of Living IndexThe ACCRA Cost of Living Index is a measure of living cost differences among urban areas in the United States compiled by the Council for Community and Economic Research. First published in 1968, the index compares the price of goods and services among areas that participate in their surveys...
- Consumer Price IndexConsumer price indexA consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
- InflationInflationIn economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
- Price indexPrice indexA price index is a normalized average of prices for a given class of goods or services in a given region, during a given interval of time...
- Cost of Living Allowance (U.S. Military)
Specific:
- List of most expensive cities for expatriate employees
- Middle class squeezeMiddle class squeezeThe middle class squeeze is the situation where increases in wages fail to keep up with inflation for middle income earners, while at the same time, the phenomenon fails to have a similar impact on the top wage earners...
- Cost of raising a childCost of raising a childThe cost of raising a child varies from country to country.-Developing countries:According to Globalissues.org, "Almost half the world — over three billion people — live on less than $2.50 a day." This statistic includes children. On this number, it costs roughly US$900 to raise a child for a year,...
External links
- Cost-of-Living Calculator relative to time from American Institute for Economic Research (AIER)
- US Consumer Price Index FAQ