Military and federal civilian retirees, survivor benefit annuitants, disabled veterans and Social Security recipients will see a 1.7 percent cost-of-living adjustment in January.

Annual COLAs for federal benefits are based on inflation, as tracked by the Bureau of Labor Statistics’ Consumer Price Index for Urban Wage Earners and Clerical Workers.

This COLA was set by comparing average prices for a market basket of goods and services tracked by CPI-W in the third quarter of last year to average prices in the third quarter this year.

That comparison shows the CPI-W average of 223.23 for July through September 2011 has climbed to 226.94 for the third quarter this year, an increase of 1.66 percent, which the BLS rounded up to 1.7 percent.

BLS economist Steve Reed said food inflation was relatively modest at 1.6 percent. Gasoline prices are high today but also were high in the third quarter of last year, climbing by only 2.6 percent since last September.

The price of durable goods, meanwhile, rose more modestly.

This COLA will be less than half of last year’s 3.6 percent adjustment, after two years without a cost-of-living raise when consumer prices fell during the recession and collapse of U.S. housing and financial markets.

Various debt reduction studies including the 2010 report of the National Commission on Fiscal Responsibility and Reform, also known as the Simpson Bowles commission, have proposed moving from CPI-W to a “chain-weighted” CPI for adjusting federal entitlement and retirement programs.

This would save an estimated $200 billion over the next 10 years.

Retirees can expect adoption of the chain CPI for Urban Consumers to be floated again when Republicans and Democrats resume negotiations on addressing the debt crisis.

If Congress had agreed to the chain CPI already, the COLA in January would be 1.5 percent rather than 1.7 percent. Proponents argue that the chain CPI addresses “substitution bias” found in the CPI-W. That market basket of goods and services is weighted based on spending patterns of American workers. And every two years BLS conducts a separate survey to readjust how those goods and services are weighted in the basket.

What CPI-W doesn’t do is change the mix of goods and services it surveys to reflect changes in spending behavior. For example, as the price of beef rises, consumers buy less beef and more chicken. CPI-W doesn’t take account of that shift so, critics contend, it exaggerates inflation.

A chain CPI would capture changes in consumer behavior. But opponents of that index argue it ignores the fact that consumers might prefer beef to chicken. And so over time they could feel worse off financially with inflation adjustments shaped more by prices than by preferences.

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