What is a Cost of Living Adjustment?

A cost of living adjustment or allowance (COLA) can refer to several different ways in which salary or benefits, like retirement pay, may be adjusted upward to account for rising expenses in the cost of living. For many years, especially among union workers, pay increases in the form of cost of living adjustment were written into employee contracts. This is less common today, even in unions, though some argue that dispensing with these agreements has sorely hurt workers or those receiving retirement benefits.

When a cost of living adjustment is in place, increases in salary are often based on the consumer price index (CPI). The consumer price index is a current measurement of what goods and services used by most households cost. When the CPI rises, as it did in the mid 2000s, especially with the price of food and gasoline, some workers with a COLA may see their salary automatically rise to meet these new costs. COLAs remains in place for many people collecting government pensions, who might have automatic increases in social security payments to meet a higher CPI.

Many companies and some economists argue strongly against cost of living adjustment arrangements for workers. Their argument is as follows: Raising salaries means that the company also must spend more, which can result in greater rise to the CPI. This creates a constant battle between rising salaries and rising costs, and in the end may threaten the continuation of a company so that workers are suddenly faced with the prospect of losing their jobs.

In contrast, proponents of companies making cost of living adjustment arrangements with workers suggest that failing to adjust salary based on significant increases in the CPI causes more workers to be unable to meet their financial obligations. There certainly are accounts by many workers, particularly those who make lower salaries, where even working a job or two jobs does not adequately meet basic expenses. With astronomical increases in gas prices in the 2000s, some people found they could no longer afford to drive to work on their salaries, since their companies offered no cost of living adjustment in salary.

Another type of cost of living adjustment may occur when workers must move to areas that are far more expensive to live. In recognition of the employee’s agreement to relocate, the company adjusts salary so that the person has roughly the same ability to purchase goods and services as he or she did in his/her former place of residence. This strategy is common in the US military when armed services members must relocate to other countries where cost of living is significantly higher. In such cases, the military evaluates the CPI for the area of relocation to see if employees will require an additional stipend to meet higher costs. Should the person locate back to a less expensive area, they usually don’t maintain their COLA because it is not considered a raise.