Chained CPI: Is Changing the Government Inflation Formula the Secret to a Deficit Deal?

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Washington is full of speculation this week as Democrats and Republicans examine different ways to cut spending, raise revenue and reform entitlements to avert the so-called “fiscal cliff.” One policy getting more attention is a new way for the government to calculate inflation. So what does that actually entail, and how much would it matter?

Over time, the federal government makes cost-of-living adjustments to benefit programs like Social Security. As time passes, payouts increase to keep up with inflation. The size of that adjustment is based on a consumer price index, a measure of how much a fixed group of goods and services costs at any given time. The Bureau of Labor Statistics monitors people’s spending habits, as well as the prices of everything from bus fares to ladies’ dresses to broccoli, and produces a variety of indexes.

Social Security cost-of-living adjustments and federal retirement benefits are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), the only index that was around when Congress mandated inflation-adjusted increases for Social Security and Supplemental Security Income in the 1970s. The CPI-W essentially estimates how much blue-collar urban workers have to spend each month to keep up the same standard of living. But many economists say this measure overestimates the effect of inflation.

In recent years, some policymakers have suggested the government use a different measure of inflation–the Chained Consumer Price Index for All Urban Consumers, known by the cumbersome acronym C-CPI-U. The “chained” index, instituted in 2002, more heavily weighs consumers’ tendency to substitute which goods they’re buying when prices change.

For example: If the cost of cashews skyrockets, people might plop peanuts in their grocery baskets. If the price of steaks rises faster than the price of poultry, a household might eat more chicken. The chained index accounts for this by linking monthly data together rather than using a biennial estimate of which goods and services are being purchased, like the CPI-W does.

So why would using chained CPI reduce the deficit? It grows more slowly—by about 0.3 percentage points annually–than traditional CPIs according to the Congressional Budget Office. That means cost-of-living adjustments for programs like Social Security would increase more slowly.

The latest cost-of-living adjustment announced by the Social Security Administration was an increase of 1.7%, which goes into effect for benefits paid in January, and will continue for 2013. Had economists used chained CPI  instead of the CPI-W, BLS economist Darren Rippy estimates that the increase would have instead been 1.5%.  The average payment to beneficiaries last month was $1,131.32: increasing that by 1.7% yields an additional $19.23 per month, while using the lower C-CPI-U number yields $16.97. But when those savings are totaled up for all beneficiaries over time, the result is significant. In a 2009 report, the CBO estimated that adopting the chained index would reduce Social Security outlays by $108 billion over a decade.

Applying the chained index to budgetary matters beyond Social Security could yield revenue, too. If it were adopted for the tax code–which currently uses an index called All Items CPI for All Urban Consumers (CPI-U)– the inflation adjustments for federal income tax brackets would grow more slowly, meaning more people would fall into higher tax brackets and send the government more money.

With the potential to produce revenue and cut spending, the chained index has gained high-profile bipartisan support. The Simpson-Bowles commission, the President’s deficit reduction team, recommended moving to the chained index for Social Security benefits and all other mandatory spending in their 2010 report. The Gang of Six, a bipartisan group of Senators tasked with producing a deficit reduction package last year, suggested a “government-wide” adoption.

Critics say chained CPI’s assumption that people will automatically switch to cheaper items—which may not be what they actually want—amounts to a lowered standard of living and a misrepresentation of the real cost of inflation. Interest groups such as the AARP–no fan of reducing Social Security payouts–oppose such a change, saying that the elderly population would suffer.

As the AARP points out, none of the official indexes are perfect measures of how costs change for the elderly; how a 70-year-old spends money is rarely close to the breakdown for a 40-year-old or 18-year-old. The BLS has started experimenting with an index specifically tailored to the elderly’s expenses, called the CPI-E. It assigns more weight to things like prescriptions and less to, say, cell phone bills, but Rippy says there’s no timetable to make the index official.

For now, the prospect of switching to the C-CPI-U has an additional catch: it takes longer for BLS economists to calculate accurate data for the chained index. The index is revised as data required for more accurate results comes in, much like monthly jobs numbers are. Monthly CPI-W numbers, by contrast, are not revised. Although the chained numbers are typically only changed a tenth of a percent or so, Rippy says, that difference makes linking them to Social Security a trickier business. “Each index has it’s own limitations,” he says, “and it’s really up to Congress to weigh the benefits and the costs.”

14 comments
lycanr1
lycanr1

This is a sham -- it's easy. You see this index allows for substitution as prices rise, and in retail this is called down-selling. It's been around for years! In fact, many polling firms like Nielsen and all are expecting consumers to move into less expensive products, get this... permanently. Nobody expects wage gains in the next 10 years.

So what the government is not telling you, is this... If you change over to Chained Consumer Price Index, then you'll never see a steak again, you'll only see chicken as the government lessens your payouts to match inflation. And what happens then? You'll be chained down to something cheaper than chicken, and then something cheaper than that!

This is a sham -- don't give in America.

deconstructiva
deconstructiva

Thanks for the explanation, Katy. I agree that this newer idea is better at keeping benefits updated. Interesting to note that beef prices have improved where I am, but that has nothing to do with politics, but weather: the recent drought caused many ranchers to thin herds, so this may lead to higher prices next year / lower now. However, as grape noted, this is separate from the so-called "fiscal cliff", and the R's attempt to connect these has everything to do with politics. The D's should refuse to give in.

bobell
bobell

Great explanation of something that's not so simple, Katy.  Thank you.

Social Security is okay for now, but it will hit a wall in a few years if we don't do some tinkering, and the sooner we start tinkering, the farther away we move the wall, assuming the tinkering is designed to reduce benefits.

But if you're going to reduce benefits, why obfuscate?  And why hit everyone with the same percentage reduction?  There's already a bit of meams testing in the Medicare Part B payments and the partial taxability of SS benefits to those with higher incomes.  Means test some more.  It will hit me if that's what's done (Mrs. bobell and I are both drawing close to maximum benefits right now), but it's an improvement over cutting the benefits of those who need them  nost.

Ever more, politics is skewing the way we deal with our problems, forcing us to choose the most cosmetically attractive solution rather than the best one.  It's getting ridiculous.

forgottenlord
forgottenlord

If the CPI-E could be made available with the chaining, I would like this.  Why?  Regardless of whether it saves money or costs more money, it would more accurately reflect the needs for the elderly and adjust resources for them - in other words, providing a better, more effective and more targeted service.  As a cost cutting measure, it doesn't make sense as Social Security is not part of the deficit problem and is supposed to be kept segregated from the problem (though it does have a deficit, but that's a different issue)

grape_crush
grape_crush

 > I'm good with this.

I'm not. What does Social Security have to do with this fabricated 'fiscal cliff'? Nothing. Weakening and eventually eliminating Social Security a right wing wish list item. Sure we can discuss what to do to keep the program solvent - raising the cap on the amount of income that goes to Social Security is one idea - but there's no need to roll any change into the current proposals.

> The “chained” index, instituted in 2002, more heavily weighs consumers’ tendency to substitute which goods they’re buying when prices change. For example: If the cost of cashews skyrockets, people might plop peanuts in their grocery baskets. If the price of steaks rises faster than the price of poultry, a household might eat more chicken.

Or, when Spam becomes too pricey, a household might move to Alpo. 

Is quality of life a factor in any of this debate?

To me, it looks like a coward's way of reducing retirement payments without having to actually say that you're cutting anything.

PaulDirks
PaulDirks

Of course when we 'adjust for inflation' what we're really trying to measure is the value of currency. The 'standard breadbasket' should therefore probably reflect more than just household spending. But it also, once established should remain unchanged.

destor23
destor23

Nicely explained, Katy.  And, you very clearly point out the flaw with the chained CPI.  If I buy steak because I like it and I've always been able to afford it but now I have to buy chicken instead because my income hasn't kept up with beef prices, how can you argue that my standard of living is being maintained.  In short, Chained CPI understates inflation by defining the standard of living down to whatever sacrifice somebody has made.

sacredh
sacredh

Thanks for the article Katy. Let me provide another example that personally affected me. The health plan I've had for 18 years raised their rates for 2013. I was paying $ 168 per pay. They raised it $ 105 per two weeks. I switched to Blue Cross and Blue Shield. They (BC & BS) raised their rates to $ 138 per pay for 2013 ($6 per pay). The benefits are very similar. I keep the same doctors and the same hospitals. My copay for drs visits went up $ 10 per visit. My copays for prescriptions went down for generic drugs but up for brand name. It's a wash. I'll save over 3k per year. I'll actually get 30 dollars more on my check per pay. It's like I got a raise.

deconstructiva
deconstructiva

@bobell Lifting the tax cap would a simple, easy start. I'm surprised Congress hasn't approved this. Oh wait, that's probably why.

Ohiolib
Ohiolib

@grape_crush The problem is that the GOP will block anything that doesn't include sufficient suffering for children and seniors. If there are going to be cuts, then let's make them fairly minor cuts cuts, like this. If it gets enough teabaggers on board, I'll give one to take two. 

bobell
bobell

@deconstructiva @bobell Sorry, de, but lifting the cap is a tax increase.  Boehner will leave the room if it's so much as mentioned.