Should We Chain the Consumer Price Index (CPI) to Reduce the Federal Deficit?

Wednesday, April 10, 2013 at 6:22 PM by

Preliminary Thoughts on the “Chained CPI,” from a Policy Perspective and Strategic Perspective 

Until recently, most Americans probably hadn’t ever heard of the “chained CPI,” and the rest of us generally tuned out any discussion of the idea.  That is likely to change significantly in the coming weeks and months, now that President Obama has endorsed it as a deficit reduction strategy.  There are many different parts of the President’s budget package that I’m tempted to write about, but this one is likely to be the most hotly contested, and it’s worth starting to explore the pros and cons.   

In a nutshell, the “chained CPI” is a way of adjusting the traditional measure of cost of living increases by taking into consideration that as certain goods and services become more expensive, people shift their consumption to other goods and services that are more affordable.  For a good summary of the issue, see the NPR story Tuesday. And for a nuanced discussion of the option of including the chained CPI in the budget bill, see Robert Greenstein’s commentary Tuesday. 

Economists estimate that the chained CPI will typically be about a quarter of a percentage point lower than the usual CPI adjustment (e.g., 1.75% instead of 2.0%).   In any given year, that doesn’t make much of a difference for the adjustments to things like Social Security benefits, but over the course of a decade or so, it amounts to very large sums of money. 

The fiscal year 2014 budget unveiled today by the President proposes using the chained CPI to calculate Social Security benefits, and for certain other purposes, such as calculating the annual adjustments to the income tax code.   It would not apply to poverty level guidelines, SSDI, Medicaid or other means-tested programs.   According to various summary documents, including this OMB synopsis,  the President’s proposal is offered as a compromise that comes with two significant conditions:

  • “The change is part of a balanced deficit reduction package that includes substantial revenue raised through tax reform;” and
  • “It is coupled with measures to protect the vulnerable and avoid increasing poverty and hardship.”

Advocates for the elderly are understandably distressed that the President recommended the proposal, because of the way it will gradually slow reduce inflationary increases in Social Security benefits.  I certainly understand that viewpoint and would prefer to see the President advocating raising the current cap on income subject to the payroll tax for Social Security.  (For a very entertaining perspective on that issue, see this video by the Economic Opportunity Institute.)  

If you haven’t firmly decided what you think of the chained CPI proposal, see Robert Greenstein’s commentary for a thoughtful analysis of arguments for and against the proposal.  He points out that most economists think the chained CPI is a more accurate measure of the cost of living, but like the current measure it tends to underestimate changes in the cost of living for seniors, for whom the more rapidly rising cost of health care doesn’t get sufficient weight in the formula.  He adds that the argument for the chained CPI is also weak for low-income people, who cannot necessarily make cost-saving substitutions in their purchases as easily as other Americans can.

From a more strategic perspective, Greenstein notes that although there are significant drawbacks to this plan, some sort of reduction in Social Security benefits is almost inevitable, and “moving to the chained CPI in Social Security is the sole such benefit reduction that is accompanied by savings in other programs and in the tax code, thereby somewhat lessening pressures on other valuable parts of the budget.”  

Greenstein concludes by saying, “the chained CPI is worth considering – but only if two crucial conditions are met.”   Those conditions are measures to “substantially ease” the impact on the very old and the poor, and revenue generating measures that ensure this entitlement concession is part of a balanced package of measures to reduce the deficit and stabilize debt.  

Of course, another question is whether the President should have unilaterally proposed this cut in an entitlement program, considering that the compromise he is putting on the table is likely to become the starting point for budget negotiations.   I won’t venture today into that debate, but I highly recommend Jared Bernstein’s blog posts, such as this one today, which touches upon the conundrum  of how to go about striking a compromise with lawmakers who show little or no willingness to budge on fiscal issues.   

Jon Peacock  

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