The Chained CPI Trap

by Reihan Salam

In making the case against adopting chained CPI for Social Security and the federal income tax, Andrew Biggs notes the following:

1. Annual cost-of-living adjustments (COLAs) for Social Security help counteract the fact that private pensions are not adjusted for inflation.

2. COLA reductions fall hardest on the oldest Social Security beneficiaries, who are also the most at risk of poverty.

3. If we reduced the initial benefit but pegged COLAs to wage growth, which tends to outpace inflation by 1 percent per annum, we could achieve a spending reduction of similar or greater magnitude while protecting the interests of the oldest and most vulnerable beneficiaries.

4. And though chained CPI has the undesirable feature of sharply reducing benefits for the oldest and most vulnerable beneficiaries, it does relatively little to address the work and fertility disincentives embedded in the Social Security program, which are the much bigger long-term concern.

5. Moreover, applying chained CPI to federal income tax brackets represents a substantial tax increase. While personal-income tax revenues have been in the neighborhood of 8.2 percent of GDP in recent years, chained CPI would increase this share by 2.6 percentage points. The bulk of this revenue increase (69 percent) will be borne by taxpayers earning less than $100,000, according to the Congressional Joint Committee on Taxation. This is despite the fact that these households account for 28 percent of personal-income tax revenues. 

6. Biggs proposes indexing personal-income tax brackets to income growth. This would help keep tax revenues stable as a share of GDP unless lawmakers explicitly propose a tax increase. 

Essentially, the Obama administration is characterizing a significant tax increase on middle-income households as a concession to Republicans by linking it to a reduction in Social Security benefits that does not actually help the program become sustainable. The congressional GOP shouldn’t go for it. The problem, however, is that the failure of congressional Republicans to advance a more ambitious Social Security reform agenda — the kind that would actually benefit Social Security beneficiaries over the long term by introducing a pre-funded savings component and a stronger minimum benefit that would increase retirement incomes — has left them with limited options in countering the chained CPI proposal.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.