Google+
Close
The Chained CPI: A Bad Deal All Around
Tax hikes and benefit cuts should be made rationally and openly, not with a stealthy statistical switch.


Text  


The Chain-Weighted Consumer Price Index (or chained CPI, for short), which President Obama included as part of his formal budget proposal, seems like a no-brainer for any White House–GOP grand bargain on the budget deficit. After all, the chained CPI is a better measure of inflation than the indices the federal government currently uses, and this simple technical fix would reduce entitlement spending and increase tax revenues by a combined $340 billion over ten years, providing something for both sides to like and dislike. Yet as pressing as federal deficits and debt are, the chained CPI is bad policy that both liberals and conservatives may come to regret.

The Chained CPI is a better measure of inflation than the current indices because, instead of simply measuring the changing price of a fixed basket of goods, it recognizes that purchasing decisions change when prices change. For instance, if the price of apples falls, people will buy more apples and fewer pears, and vice versa. This holds true regardless of which fruit is more expensive to begin with.

Advertisement
Controlling for these changes yields inflation rates around 0.3 percentage points lower than those calculated with the fixed-basket approach. The Bureau of Labor Statistics states that the chained CPI “is designed to be a closer approximation to a cost-of-living index than other CPI measures.” And the BLS is right — but it’s not as simple as merely getting a more accurate measure of inflation. With both Social Security and the tax code, a better inflation measure could lead to worse public policy.

In Social Security, the chained CPI would replace the CPI-W (intended for urban wage-earners and clerical workers) in calculating annual cost-of-living adjustments (COLAs). Once fully implemented, lower COLAs would reduce a retiree’s average lifetime benefits by around 4 percent, cutting Social Security’s long-term shortfall by around one quarter.

Yet while Social Security does need to be fixed, and lower benefits for middle and high earners should be a part of the equation, smaller COLAs weaken a feature of Social Security that actually works: The program’s generous inflation adjustment counteracts the absence of inflation adjustment in private pensions. And unlike most reforms, which reduce benefits progressively — meaning that the poorest pay the least and the wealthiest the most — COLA reductions fall hardest on the oldest beneficiaries, who are most at risk of poverty. An 85-year-old is 66 percent more likely to be in poverty than a 65-year-old, but the chained CPI will cut the 65-year-old’s by only 1 percent and the 85-year-old’s benefits by 8 percent (since the 85-year-old will have 20 more years of having his payment shaved). Moreover, the chained CPI, like CPI-W, doesn’t account for the fact that older retirees spend disproportionately on health care, a sector in which inflation is particularly high.

A better policy would peg COLAs to wage growth, which is around 1 percentage point faster than inflation, coupled with a lower initial retirement-benefit level to keep lifetime receipts the same. The lower starting benefit would dissuade workers from retiring too early. Higher benefits later in life would focus resources where the danger of poverty is greatest, as well as compensating for the fact that most non–Social Security sources of retirement income aren’t inflation-indexed at all.

And despite reducing payouts to retirees, the chained CPI wouldn’t come close to making Social Security financially sustainable. While policymakers have focused on health care, Social Security’s 75-year shortfall rose from $4.3 trillion in 2008 to $8.6 trillion in 2012. Adopting the chained CPI wouldn’t even bring Social Security’s deficit back to 2008 levels. Social Security needs fundamental reforms if it is to become both solvent and effective for those who need it the most. And politics matter as well: Conservatives need to pay as much attention to making government programs work better as they do to making those programs smaller.



Text