ECONOMICS - More Accurate Inflation Adjustment Could Cut $300 Billion From Deficit

"Chained Explained" by Brooks Jackson, FactCheck.org 12/11/2012

Excerpt

Summary

Using a more accurate cost-of-living adjustment for federal benefit payments and tax brackets would cut the federal deficit by perhaps $300 billion over the next 10 years. But it faces opposition from both right and left.

Economists generally agree that the “chained” Consumer Price Index is a more accurate way to measure the cost of living than the traditional CPI. Republican leaders and some Democrats favor it as part of the solution to the “fiscal cliff” dilemma, as does at least one leading liberal group.

Nevertheless, the AARP objects to using it to make cost-of-living adjustments for Social Security, because it would result in slightly lower yearly increases, and Grover Norquist’s Americans for Tax Reform objects to the slightly higher federal income tax liabilities that would result from using it to adjust tax brackets for inflation each year.

Leading economists have pointed out for at least half a century that the traditional CPI goes up faster than the average person’s actual cost of living. The flaw in the traditional CPI is that it simply measures prices of goods and services in a “market basket” that doesn’t necessarily reflect what people are buying in any given month. When the price of beef spikes, consumers often switch to pork or chicken, but the traditional CPI assumes they keep buying and paying for the higher-priced meat.

The “chained” CPI adjusts for such switches. Thus, it more accurately measures what the average consumer actually spends for goods and services. It also rises somewhat more slowly than the traditional CPI.

Using the “chained” CPI to adjust federal benefit payments and tax brackets would automatically trim the growth of future spending — and increase future revenues — without making any other changes in entitlements or tax laws. According to the Congressional Budget Office:

• Social Security payments to seniors and the disabled would rise by an average of one-quarter of 1 percentage point less each year. Put another way, an increase of $100 under the current system would become an increase of $99.75.
• Over time, such small changes would compound. After 10 years of reduced cost-of-living increases, a Social Security beneficiary would be getting about 3 percent less per month than under the current system, for example. And by age 95, a Social Security pensioner retiring today would be getting about 8 percent less.
• The same would also be true for annual cost-of-living adjustments for retired federal workers, retired military and veterans’ benefits.
• On the tax side, using “chained” CPI to adjust federal income-tax brackets for inflation would bring in an additional $72 billion in revenue without any increase in rates, CBO estimates. That’s because bracket thresholds would rise more slowly, leaving more income in brackets taxed at higher rates.

CBO estimated that using the “chained” CPI for all federal programs (including some it didn’t specify) would save $145 billion in spending over 10 years, and bring in $72 billion in added revenue, for a total of $217 billion in deficit reduction. Another, independent estimate, adding in savings from interest payments for money that would not have to be borrowed, brings the total 10-year deficit reduction to nearly $300 billion.

Many who oppose using the chained CPI assert that seniors experience a more rapid rise in their cost of living than others. But over the years, economists have found no clear evidence of that.

Seniors do spend more on medical costs than younger persons, and medical costs rise more rapidly than other prices. But seniors also spend less on such things as insurance, college tuition and gasoline.

It’s true that the Bureau of Labor Statistics calculates an unpublished index (the CPI-E, for “elderly”) that attempts to measure consumer prices paid by those age 62 and over. But the results are inconclusive.

The experimental index rose slightly faster than the traditional CPI for a number of years. But since 2006, the “elderly” index has gone up a little more slowly than the index used to adjust Social Security benefits.

The BLS concedes that the experimental index suffers from multiple shortcomings. It doesn’t measure prices where seniors actually shop, or the goods and services they actually buy, for example. A 2002 report for the National Research Council also noted those deficiencies, and found the CPI-E unsuitable for indexing benefits. The panel said a valid measure of spending by seniors should not be based on “speculation and conjecture.”

Analysis and Sources follow Summary in full article.