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.
COLAs are not merit-based raises. They are almost always applied across an organization or population of annuitants. Notable exceptions would be companies with workers spread across the US or the world. In those cases a company would consider COLAs that vary by geographic region.
COLAs that are not based on an objective measure are doomed either to be inadequate to maintain buying power or to be unnecessarily high; therefore, it would be somewhat of a misnomer to call those raises COLAs.
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 US Social Security Administration is required by law to use the CPI-W to calculate their annual COLAs to their annuitants. The CPI-W is calculated by the US Bureau of Labor Statistics.
US 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.
Private Sector COLAs
Businesses in the US are not required to provide their workers with COLAs; however, many do. Employment market forces work quickly against employers who do not maintain their employees’ salaries.
Sometimes union contracts have cost of living adjustments built into them. Union leaders push for absolute numbers in negotiations so they have guaranteed wage increases. While management has an incentive to know precisely how much money will be paid in wages each year, a COLA based on objective criteria ensures that management will not overpay for automatic wage increases.