Tags: Social Security | chained CPI | CPI | deficit

Chained CPI’s Diminishing Returns for US Budget

Monday, 08 April 2013 12:24 PM

News that the White House will propose a new cost-of-living index in the budget it releases this week has brought joy to deficit scolds and consternation to defenders of Social Security.

The measure, called the chained consumer price index (CPI), would lower the annual payment increases for Social Security beneficiaries, saving the government money as it lowers the future monthly income of retirees and disabled Americans. The change would also raise revenue over time because it would cause more taxpayers to wind up in higher marginal brackets.

What neither side seems to have noticed, however, is that the difference between the chained CPI and the standard CPI has been diminishing. That means the impact of switching indexes may not be as great as many assume. The change may still be a good idea, but it probably won’t matter as much as expected.

A decent guess is that, over the next decade, the effect on the deficit of adopting the chained index would be less than $150 billion. Social Security benefits even 20 years after retirement would be reduced by less than 2 percent. This does not amount to bold long-term deficit reduction. On the other hand, it wouldn’t be the end of Social Security as we know it either.

It may lead some people to ask why policymakers should bother — though I would still support making the shift.

Standard Indexes

To understand why the chained CPI would save less money than hoped, it helps to know some background about the federal retirement and disability program, as well as the tax code.

Once an American begins to claim Social Security benefits, his monthly checks increase each year in line with a consumer price index called the CPI-W (the “W” is there because the index was created to measure inflation for workers). The federal tax code, for its part, is indexed to a related measure, the CPI-U, which is the inflation measure that receives the most attention each month.

The Bureau of Labor Statistics, which calculates both indexes, also publishes the chained CPI, which is a more accurate measure of inflation because it better reflects how people change what they buy in response to price increases. When the price of apples rises relative to oranges, for instance, people eat more oranges, and the chained CPI accounts for this substitution, reducing the measured inflation rate.

The result is that the chained CPI rises more slowly than either the CPI-W or the CPI-U. Switching to the chained index would therefore cause Social Security checks to grow more slowly. And if the Internal Revenue Service switched to the chained CPI as well, the cutoff lines for tax brackets would rise more slowly, pushing more Americans into higher marginal tax brackets and thereby raising revenue.

Official budget estimates suggest that switching to the chained CPI would save the federal government about $125 billion on Social Security benefits and about $40 billion in other indexed benefits (such as federal civilian and military pension payments) over the next decade, and raise about $125 billion more in tax revenue. It would also save about $30 billion in health programs and nearly $20 billion in refundable tax credits. That adds up to total deficit reduction of about $340 billion. The Social Security actuaries suggest that it would also reduce the 75-year actuarial gap in the program by about 20 percent.

These official estimates all assume, however, that the chained index grows 25 to 30 basis points more slowly than the standard indexes do. That’s a reasonable assumption based on the average difference in how fast the indexes have risen over the past 13 years. From January 2000 to January 2013, the chained CPI rose 27 basis points more slowly each year, on average, than the CPI-U did and 29 basis points more slowly than the CPI-W did.

Smaller Difference

Over the course of those 13 years, however, the differences between the annual growth rates of the indexes have become substantially smaller. From January 2000 to January 2003, the annual increase in the chained index was 47 basis points lower than that in the CPI-U. From 2003 to 2006, the difference was 31 basis points. From 2006 to 2009, it dropped to 15 basis points. And over the past two years, the average difference has been just 11 basis points.

Why is this happening? Examining the subcomponents of each index, it appears that housing and other goods and services have played a role. Sorting through the causes is complex, however. In any case, the more relevant question is, what is the best time period to use as a historical basis for projecting future differences in the indexes?

Given that the gaps have narrowed so much in recent years, it probably doesn’t make sense to take the average all the way back to 2000.

Consider what future projections look like if we instead assume that the chained index will grow just 10 basis points a year more slowly than the current indexes. In that case, the deficit reduction from switching to the chained index would be less than $150 billion over 10 years, rather than $340 billion. And the reduction in the long-term Social Security deficit would be about 7 percent, rather than 20 percent.

This would make a pretty big difference in the effect on Social Security benefits. For an 85 year old who began receiving checks at 65, checks would be about 2 percent less, rather than 6 percent if the chained index were to grow 25 to 30 basis points more slowly than the standard index.

(By the way, since no one goes back to revisit budget scoring, progressives could get the best of this deal: If the chained index grows more slowly than the official estimates assume, the initial deficit score would be disproportionate to the actual impact on beneficiaries.)

President Barack Obama deserves credit for political courage in being willing to adopt the chained CPI — in the face of strong opposition from members of his party. But if switching to the chained index reduces the 10-year deficit by less than $150 billion and the 75-year Social Security actuarial gap by less than 10 percent, can a “grand bargain” built around it really be all that grand? And if it reduces benefits for an 85-year-old retiree by less than 2 percent, is it really so destructive?

Peter Orszag is vice chairman of corporate and investment banking and chairman of the financial strategy and solutions group at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.

© Copyright 2018 Bloomberg News. All rights reserved.

1Like our page
News that the White House will propose a new cost-of-living index in the budget it releases this week has brought joy to deficit scolds and consternation to defenders of Social Security.
Social Security,chained CPI,CPI,deficit
Monday, 08 April 2013 12:24 PM
Newsmax Media, Inc.

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

© Newsmax Media, Inc.
All Rights Reserved