The cost of living it up.

What Richard Nixon considered perhaps his biggest presidential mistake was hatched in a high stakes game of political chicken. And it had nothing to do with Watergate.

It was 1972, and Congress was poised to pass the fourth increase in Social Security benefits in five years. The first three had totaled over 40 percent, well outdistancing the cumulative 27 percent inflation rate. But the economy was strong, and it was an election year. Nixon signaled to Congress that he was willing to sign a 5 percent increase--but no more.

The Democratic-controlled Congress was moving towards a 10 percent increase, apparently believing Nixon would veto the bill and take the heat at the polls. Then, according to Eugene McCarthy, who had just left the Senate but was still in contact with his colleagues at the time, word got to Congress that Nixon would call their bluff and sign the bill.

Wilbur Mills, chairman of the House Ways and Means Committee, wasn't about to let him off that easily. Mills, a powerful Democrat in a highly partisan arena, was also a presidential candidate. He saw a golden opportunity: In one fell swoop, he could curry favor with the senior citizen vote and hold Nixon's feet to the fire. He pushed a 20 percent increase onto the bill extending the federal debt ceiling and effectively dared Nixon to veto it.

But Nixon didn't blink--he signed the bill and made sure he got his share of the credit for the fattened benefit checks. As expensive as the 20 percent raise was, though, the fiscal damage had just begun. Because attached to that bill was a provision that permanently indexed Social Security benefits to the Consumer Price Index (CPI), ensuring annual benefit increases and making future appropriation games unnecessary. Good-bye political chicken. Hello COLAs.

At the time, the annual Cost of Living Adjustments had broad bipartisan support. Federal civil service and military pensions had been indexed to the CPI in the early sixties, and many lawmakers saw COLAs as a way to compensate for rising inflation huge election-year benefit increases. But neither Nixon nor anybody else anticipated the coming decade's severe oil shocks and double-digit infla tion. No one knew that Social Security benefit would virtually double after just eight COLAs and that the average beneficiary would, by 1981, be receiving annual checks worth more than hal of his final working wage, compared to only 38 percent in 1974. Nb one realized how badly the CPI overstated housing costs-especially for the elderly, who were more likely to have paid their mortgages--and how this would artificially inflate COLAs beyond any real increase in the cost of living.

Further, no one foresaw just how much federal retirement benefits would outpace wages in the coming decade's unprecedented combination of economic stagnation and raging inflation. In 1972, federal officials were confident that a growing economy would easily cover the cost of CO LAs. Wages, they predicted, would continue to grow by 56 percent every two decades. However, over the next two decades, median earnings fell by about 15 percent. Meanwhile, inflation soared into the double digits--and Social Security bene fits rose as well, point by point, with the Consumer Price Index. Between 1970 and 1982, average Social Security benefits rose 37 percent in real terms. The elderly saw their real median household income increase -28.4 percent between 1973 and 1991. Meanwhile the median household income for those between 25 and 34 dropped almost 10 percent. Welcome to the modem era.

As the Social Security system became more and more expensive--even requiring emergency congressional reprieves in 1977 and 1983 --Nixon, the last president to sign a balanced budget, regretted that COLAs made it so much harder for any successor to do the same. It was, he told the Concord Coalition's Peter G. Peterson, his "most serious economic and fiscal mistake."

But Social Security wasn't the only program to balloon during the decade of stagflation. Federal civil service and military pensions have doubled as a percentage of federal spending since 1970. At an annual cost of $65 billion, they are now the nation's fourth largest entitlement, after Social Security, Medicare, and Medicaid. It is estimated that one-half of current federal pension costs are due to COLAs, and that hundreds of thousands of federal retirees actually receive more money in retirement than they did while working.

The Wasteland

With the CPI at 2.6 percent--continuing a decade-long trend of low inflation--one might wonder, what's the problem with COLAs now? Simple. They're wasteful and unfair. Unfair because Cost of Living Adjustments insulate certain groups (those who get them) from the effects of inflation, while leaving others (those who don't) to bear its brunt. For instance, federal retirees are virtually the only Americans to get full COLAs as a part of their pension plans. Only 5 percent of private plans provide annual adjustments for inflation, and very few of those plans provide full COLAs. In fact, two-thirds of all workers don't even get pensions. In terms of total household income, federal retirees tower above the rest of America. The average income for households age 65 and over was $24,424 in 1991. The average income for federal retirees' households was about twice that: $52,248 for military retirees; $45,912 for retired civil servants.

And COLAs are wasteful because Uncle Sam gives them to people who don't need the money. An annual $100,000 congressional pension gets the same percentage increase as a $10,000 civil service pension. But in dollar amounts, that increase is 10 times larger. Former Congressman Hastings Keith, for example, receives four annual federal pensions (congressional, military, civil service, and widower's), which will pay him $115,000 this year alone. That means that every year he gets three times what he contributed during his entire work history.

Keith, who founded the National Committee on Public Employee Pension Systems 15 years ago, says full COLAs on entire pension benefits are unnecessary, and he's right. He receives 15 times more in COLAs than the average Social Security recipient. This year, he'll receive $263 a month in COLAs alone.

"That's not the cost of living," says David Keating of the National Taxpayers' Union. "It's the cost of living it up."

As everyone in Washington knows, it's easier to give than to take away, and COLAs are no exception. Retired federal employees- like Social Security recipients--fiercely guard their benefits and their COLAs. The National Association of Retired Federal Employees, with half a million dues-paying members, was the 20th largest PAC contributor in the 1992 election cycle (and the fifth largest contributor in 1988). Add the election contributions of the three postal employee associations, and federal employees outspent the country's largest PAC, the American Medical Association, by 40 percent. Any politician who has ever suggested cutting Social Security is also painfully familiar with the power of the 34 million-member American Association of Retired Persons (AARP).

Both Presidents Bush and Clinton eyed minor COLA cutbacks as a way to reduce the deficit--Bush for federal pensions, Clinton for Social Security. Both were lambasted, not just by the lobbies but by their own parties in Congress. Yet, without a major overhaul, the portion of the budget taken up by pensions and Social Security will continue to balloon; over the next five years, according to the Congressional Budget Office (CBO), entitlement increases from COLAs will add up to $221 billion.

With the budget ostensibly moving toward balance, this is a common sense cut. "COLA restrictions would achieve considerable savings," the CBO has concluded, "by exacting small reductions in benefits from a large number of people, in contrast to other budget options that would impose large reductions in benefits on smaller groups of recipients."

One way to reduce the size of COLAs is through an adjustment in the Consumer Price Index. A host of policymakers, from Federal Reserve Chairman Alan Greenspan to Senators Bob Dole and Daniel Patrick Moynihan, are interested in reducing the CPI (and thus lowering COLAs) because of widespread agreement that the index does not accurately reflect the real cost of living. Economists claim, for instance, that the CPI fails to consider the fact that when one product becomes more expensive, consumers buy a cheaper product, or they go to a discount outlet and pay less than standard retail. A Senate Finance Committee commission recently identified five such biases, and tentatively concluded that the CPI is between 0.7 and 2 percentage points too high. It will issue a final report next June.

Clearly, the CPI should be made as accurate as possible. The CBO predicts that a one-point reduction would save $634 billion over 10 years (though a large share of this would come from increased tax receipts because of the effect on tax brackets.).

But a reduction in the CPI doesn't do enough to remedy the waste and unfairness of COLAs. The best reform plans all have one element in common: They retain COLAs for those who truly need them and reduce or eliminate them for those who don't.

Senators Bob Kerrey (D-Neb.) and Alan Simpson (D-Wyo.), the main congressional crusaders against entitlement waste these days, included a COLA reform act in their eight-part plan this spring. They would limit full COLAs to the 30 percent who get the smallest benefits in each federal retirement program, including Social Security. So if there were 100 people in a program, only the bottom 30 would get a full COLA. Everyone else would get what the 30th person is getting. That means everyone would get enough of an increase to meet basic living needs, but the obscene increases would end.

Reducing or eliminating COLAs for retirement benefits above a certain level would be a good start, but even that approach is imperfect. Retirees with large benefits but small total incomes would suffer, while wealthier retirees with smaller benefits would get full COLAs. The best way around this is to use the income-tax system to withhold COLAs (or, better yet, benefits) from those whose income exceeds certain levels. It's a bitter pill for Congress to prescribe, but with entitlements eating more and more of the budget every year, the country's long-term health depends on it.