Politics & Policy

What Chained CPI Means

It's a subtle way to cut spending and raise taxes. Fair? Depends on whom you ask.

What kind of economic metric can be called “a moral and economic disaster,” “unconscionable,” and “a fraudulent premise”? A chained Consumer Price Index for all urban consumers —“chained CPI,” for short (C-CPI-U, if we’re really being austere). Applying this measure across the U.S. government’s tax and spending policies would apparently be a crime against humanity.

And yet it’s been a popular entitlement-reform proposal from conservatives for many years now, was a feature of the Simpson-Bowles and Domenici-Rivlin bipartisan deficit-reduction plans, and has now been included, with a couple of tweaks, in President Obama’s 2014 budget proposal.

What is the difference between chained CPI and the status quo? Chained CPI, most simply, is a lower estimate of inflation, and probably a more accurate measure of how much the cost of living increases each year. It can have big consequences for the federal budget.

#ad#Currently, the government uses two main indexes of inflation from the Bureau of Labor Statistics (BLS): CPI-W, the original inflation measure, and CPI-U, a measure that considers a wider sample of consumers. But they’re pretty much the same thing. Both measure, each month, the combined price changes of a certain “basket” of goods and services. Privately gathered data tend to track the BLS’s numbers quite closely.

But the composition of these baskets is comprehensively revised only about every decade, and choices within spending categories, such as food or transportation, aren’t adjusted when prices on certain items in those categories change. The classic example is that if the basket includes spending $50 on beef per month, and the price of beef doubles, the CPI-U and CPI-W will show that the cost of living has increased by $50. Actual consumers are likely to buy more of another meat product, or different foods altogether, reducing the cost-of-living increase or eliminating it entirely.

Chained CPI is a way of constantly adjusting the existing baskets of goods to take these choices into account. The term “chained” refers to the fact that each “link” in the “chain” involves new weighting of the data, rather than being based on the original assumptions of the index. A chained price index suggests that the cost of living is growing slightly more slowly than official government calculations hold, and the BLS itself explains that the traditional Consumer Price Index is “an upper bound” to actual cost-of-living increases — even though it’s what the Social Security Administration currently uses to calculate cost-of-living increases.

Since the BLS started publishing a chained CPI in 2000, these inflation estimates have been on average 0.3 percentage points, or 30 basis points, lower than the rates calculated using the standard measures.

Replacing the federal government’s inflation indexes with chained CPI would do two main things: First, it would reduce the rate of growth in a given senior citizen’s Social Security benefits each year by 0.2 or 0.3 percentage points. Spending would be reduced on some other inflation-tied programs, too. Second, each year, several hundred dollars of each American’s income would slip into a higher tax bracket, as the thresholds would be raised more slowly than they would be otherwise. This would raise Americans’ taxes very slowly over time, resulting in, ten years from now, most people’s paying about 0.2 or 0.3 percent more of their incomes in taxes, or a little over $100 a year for those making under $100,000 (more in dollars, but smaller percentage increases, for those above).


The savings are significant: The CBO calculates that it would reduce the federal deficit by about $340 billion over the next ten years. That breaks down as $216 billion in spending reductions and $124 billion in tax hikes; combined, they will equal more than half of what 2013’s income-tax increases will do for the deficit picture over the same time period. More important, these savings will increase after the CBO’s ten-year window, in part because tax brackets will continue to creep up, but mostly because Social Security payments, which are hard hit by chained CPI, will be growing as a share of the federal budget. (These savings are reduced in the president’s budget to $230 billion because he maintains some payments to Social Security disability recipients and exempts the oldest SS beneficiaries.)

Former Obama OMB director Peter Orszag raised one important point this week: Chained CPI has only been calculated for the past 13 years, so we don’t know a whole lot about the difference between it and the usual inflation measures, but the gap between the two has shrunk noticeably over time, from 47 basis points between 2000 and 2003 to 15 basis points between 2006 and 2009 and just eleven basis points over the last two years. The CBO’s predictions rely on a 25-basis-point difference between existing inflation measures and the new one, and it’s possible that the difference will be smaller than that.

#ad#Orszag presents his own, less impressive deficit-reduction numbers on the assumption that the spread over the next ten years will be just ten basis points. But retroactive assessments of inflation rates have been done, and it appears that, over the course of decades, the spread between chained indexes and traditional indexes is usually around 20 basis points — still slightly less than the CBO predicts, but more than Orszag assumes. The point remains important: If chained CPI converges with the normal CPI, we could see very little improvement in Social Security’s finances, even after the president and Congress touched the third rail.

Liberals have been most vociferous in their attacks on chained CPI because they oppose any entitlement cuts at all, but they have another line of attack. It’s not actually a more accurate depiction of cost-of-living changes for seniors, they claim; in fact, inflation rates facing seniors tend to be higher than others. In part to address this concern, the BLS has an experimental, unofficial price index for those over the age of 62, which has indeed increased slightly more quickly than the normal CPI. It isn’t considered reliable, however, and in 2012 it was lower than both chained CPI and normal inflation. Some liberals have suggested that the BLS should be tasked with coming up with an accurate chained index specifically for the elderly, which might be possible.

But that will be missing the point: Chained CPI has been proposed because it is expected to slow one of the ways in which Social Security benefits are scheduled to increase, though it also happens to reflect that those increases were probably more generous than intended. Debating the most accurate measure of inflation is merely the most politically palatable way of limiting how much we are willing to promise in retirement benefits to every American. That kind of limitation has to happen somehow, unless Americans would prefer significantly higher taxes, much less spending on other federal priorities, or permanently higher levels of debt.

— Patrick Brennan is a William F. Buckley Fellow at the National Review Institute.

Patrick Brennan — Patrick Brennan is a writer and policy analyst based in Washington, D.C. He was Director of Digital Content for Marco Rubio's presidential campaign, writing op-eds, policy content, and leading the ...

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