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Fiscal Cliff

Alternate inflation index could save billions

Mark Garrison Dec 13, 2012
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Fiscal Cliff

Alternate inflation index could save billions

Mark Garrison Dec 13, 2012
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Fiscal cliff talks have brought into the mainstream a phrase previously little-known outside economic policy circles: Chained Consumer Price Index. The concept is as complicated — evidenced by a jargon-splattered FAQ on the Labor Department’s website — as its impact could be massive. The government uses CPI to calculate everything from Social Security checks to tax brackets, which means switching to Chained CPI could slow growth in benefit payments and shift more people into higher tax brackets.

The CPI measures the price of various goods over time. But it doesn’t really account for how humans behave when prices go up. Sometimes they buy less of items that become more expensive. For example, rising beef prices will affect the CPI. But consumers may just buy more pork instead.

Chained CPI accounts for this shift in consumer behavior, what economists call the substitution effect. The simple act of switching the way we measure inflation could save hundreds of billions of dollars. That’s because chained CPI is lower than the benchmark CPI. If life really isn’t as expensive as we thought, the government doesn’t have to pay as much in benefits.

Benefits will still continue to increase over time, just more slowly. One place where a switch to Chained CPI will have major impact is Social Security, which is why powerful seniors interest group AARP has a flotilla of lobbyists fighting this idea.

“That money would come straight out of the pockets of individuals who are already retired,” says Cristina Martin Firvida, AARP’s director of financial security.

AARP argues Chained CPI is unfair to older Americans because their high medical costs aren’t factored in. The group favors calculating benefits based on yet another obscure Consumer Price Index variant: CPI-E. It’s an experimental measure of inflation based on the living expenses of Americans 62 and older. Using this as a Social Security benchmark would require even more generous Social Security payments than now.

Politicians know that older people vote. Even though a switch to Chained CPI could do wonders for America’s budget, like so many fiscal cliff issues, the politics is a lot trickier than the math.

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