What Is the Cost of Living Adjustment?:
On the whole, businesses don't use it because they are more likely to hire, give raises, and fire based on merit. That's because businesses compete with each other to remain profitable. If workers contribute to that profitability, they are given raises -- regardless of whether the cost of living has increased or not. If they don't contribute, they won't get raises, and they might even get fired. However, businesses often award cost of living adjustments when valued employees are asked to move to a more expensive location.
Government workers and recipients of government benefits aren't in such a competitive environment. Therefore, elected officials have made sure their incomes keep up with inflation.
How the Cost of Living Adjustment Is Calculated:
History of COLA:
Prior to 1975, Congress had to act to change the Social Security benefits. After COLA was introduced, benefit increases were automatically tied to rising prices. The adjustments occurred right in the nick of time. In 1975, COLA rose 8%, fell back to 6% for a few years, then skyrocketed to 9.9% in 1979, 14.3% in 1980 and 11.2% in 1981. By that time, then-Federal Reserve Chairman Paul Volcker had raised the Fed funds rate to 20%. This tamed inflation (and unfortunately caused a recession).
Since then, COLA has remained below 6%. That's because double-digit inflation has largely been tamed. Thanks to Volcker, businesses know they can only raise prices so far before the Federal Reserve will step in and raise interest rates. In fact, COLA has been at 4% or less since 1992. The only exception was in 2008, when COLA rose to 5.8%. That was only because of spiking oil prices caused by commodities trading. (Source: Social Security, Cost of Living Adjustments)
Why Inflation Is No Longer a Threat:
There are three other reasons why inflation is no longer a threat. First, China and other exporters have a lower cost of living themselves. This allows them to pay their workers less, and keep the price of imports from their countries low. In addition, China pegs the value of its currency to the dollar, further insuring low prices.
Second, innovations in technology also keep prices down. For example, new features from smart phones, tablets and iPods keep lowering the prices of personal computers.
Third, the 2008 financial crisis walloped economic growth, thereby lowering demand. Instead of raising prices, businesses lowered them, cutting costs and creating high unemployment. Wages are much lower than before the recession for many people, if they can get jobs at all.