President Obama with: Rob Nabors, Assistant to the President for Legislative Affairs; Jeffrey Zients, Acting Director of the Office of Management and Budget; and Chief of Staff Jack Lew

Thoughts on the Chained CPI, Social Security, and the Budget

According to reliable sources, the Obama administration is seriously contemplating a deal under which the annual cost of living adjustment for Social Security benefits would be indexed to the chained consumer price index rather than the CPI for wage and clerical workers (CPI-W) to which it is now indexed. This will lead to a reduction in benefits of approximately 0.3 percentage points annually. This loss would be cumulative through time so that after 10 years the cut would be roughly 3 percent, after 20 years 6 percent, and after 30 years 9 percent. If a typical senior collects benefits for twenty years, then the average reduction in benefits will be roughly 3 percent.

There are a few quick points worth addressing:

1. The claim that the chained CPI provides a more accurate measure of the cost of living;
2. Whether Social Security benefits are now and will in the future be sufficient to allow for a decent standard of living for retirees; and
3. Whether this is a reasonable way to be dealing with concerns over the budget.

This are taken in turn below.

Is the Chained CPI More Accurate?

While many policy types and pundits have claimed that the chained CPI would provide a more accurate measure of the cost of living for seniors, they have no basis for this claim. The chained CPI is ostensibly more accurate for the population as whole because it picks up the effect of consumer substitution as people change from consuming goods that increase rapidly in price to goods with less rapid price increases.

While this is a reasonable way to construct a price index, it may not be reasonable to apply the consumption patterns and the substitution patterns among the population as a whole to the elderly. The Bureau of Labor Statistics (BLS) has constructed an experimental elderly index (CPI-E) which reflects the consumption patterns of people over age 62. This index has shown a rate of inflation that averages 0.2-0.3 percentage points higher than the CPI-W.

The main reason for the higher rate of inflation is that the elderly devote a larger share of their income to health care, which has generally risen more rapidly in price than other items. It is also likely that the elderly are less able to substitute between goods, both due to the nature of the items they consume and their limited mobility, so the substitutions assumed in the chained CPI might be especially inappropriate for the elderly population.

While the CPI-E is just an experimental index, if the concern is really accuracy, then the logical route to go would be for the BLS to construct a full elderly CPI. While this would involve some expense, we will be indexing more than $10 trillion in Social Security benefits over the next decade. It makes sense to try to get the indexation formula right.

Are Social Security Benefits Adequate?

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The Serious People are after your social security.

The Very Serious People have taken off the gloves. There are no rules when it comes to the battle over Social Security and Medicare as Brooks Jackson shows in his “FactCheck” on the use of the chained CPI to index the Social Security cost-of-living adjustments (COLA).

Jackson strongly endorses the use of the chained CPI, describing it in the first sentence as “a more accurate cost-of-living adjustment.” The chained CPI would have the effect of reducing the annual COLA by approximately 0.3 percentage points. This reduction would be cumulative (e.g. 3 percent after 10 years, 6 percent after 20 years), leading to an average cut in lifetime benefits of approximately 3 percent for the typical beneficiary.

To push his case, Jackson seriously misrepresents the evidence. There is reason to believe that a chained index provides a better measure of inflation, since it takes account of the substitution between goods. However, the Bureau of Labor Statistics (BLS) has been producing an experimental elderly index (CPI-E) for almost three decades, which has generally shown a somewhat more rapid rate of inflation that the standard CPI currently being used to index Social Security benefits. The CPI-E would imply that the current COLA has been underadjusting for inflation, not overadjusting.

Jackson notes the CPI-E, but dismisses it as:

an unpublished, ‘experimental’ index

He then cites BLS’s warning that:

any conclusions drawn from it should be used with caution.’ BLS also concedes that the CPI-E has a number of shortcomings because it simply re-weights the price data collected for its regular price surveys, without attempting to collect some important data specific to seniors.

Given that this experimental index has shown evidence that the elderly see a higher rate of inflation than the population as a whole, it would seem that anyone concerned about having an accurate measure of the rate of inflation experienced by the elderly would want to see the BLS construct a full CPI-E. In fact, several hundred economists recently signed a statement calling on BLS to construct such an index. This would be the obvious route to go for anyone interested in an accurate index for the inflation adjustment of more than $10 trillion in Social Security benefits over the next decade.

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