What to expect from the chained CPI

Commenter extraordinaire anne at Economist’s View posted a very helpful brief from Alan Barber and Nicole Woo of the CEPR on the disaster that a switch to the chained CPI poses for those dependent on Social Security, and less obviously, on the middle class in general. The executive summary:

In the debate over federal budget deficits, several politicians have proposed to change the formulas that determine benefit levels for Social Security and other government programs as well as income tax brackets. Switching to a relatively new formula, the Chained CPI, would help the federal government save money by slowing increases in benefits and raising additional tax revenue.

Proponents of this proposal argue that the Chained CPI is a more accurate formula and any impact on beneficiaries of the government programs affected would be mitigated by increased tax revenue from the wealthy. However, research and data effectively refute those arguments by showing that:

  1. Switching to the Chained CPI would result in cuts to already modest Social Security benefits.
  2. It is likely that the Chained CPI is not an accurate measure of the inflation rate seen by seniors.
  3. The Chained CPI would lead to income tax increases for working Americans.

The authors conclude the following about the first point (emphasis added):

The Chained CPI is relatively new and has only been calculated by the BLS since 2002. It has shown a rate of inflation 0.3 percent lower than the current index used to calculate Social Security’s annual cost-of-living adjustment. Over time, changing to the Chained CPI would result in significant cuts to Social Security benefits: a cut of roughly 3 percent after 10 years, about 6 percent after 20 years, and close to 9 percent after 30 years. In addition, lower-income retirees would lose much larger proportions of their income than wealthy ones….

…For the average worker retiring at age 65, this would mean a cut of about $650 each year by age 75 and a cut of roughly $1,130 each year at age 85.5.

I’ve seen similar figures elsewhere, and will post the graph if I come across it again, but for now I will just say that these findings are consistent with what others are reporting.

The second point – that the chained CPI is inappropriate because it doesn’t measure the inflation seniors face – is philosophically interesting but politically beside the point. The move to this new measure is hardly driven by a quest for accuracy (which Barber and Woo no doubt know – it’s obligatory in these briefs to push back on all arguments, which they do very well).

The third point was a surprise, though it should not have been. By slowing the growth of measured inflation below that of the economy in general (CPI already underestimates inflation by some measures, so the new, lower chained CPI will worsen that problem), this shift will mean that the income hurdles for moving from one bracket to the next will rise more slowly than actual incomes. This would mark yet another shift of tax burden from the wealthy to those lower on the pyramid. The relevant finding:

According to Congress’ Joint Committee on Taxation, if individual income taxes were indexed to the Chained CPI starting in January 2013, by 2021, 69 percent of the gains in revenue would come from taxpayers with incomes below $100,000, while those in the highest income brackets would barely be affected. For example, workers with incomes between $10,000 and $20,000 would experience an increased tax burden of 14.5 percent, while those with incomes over $1,000,000 would just see an increase of 0.1 percent.

It’s not clear to me which would be worse – this or raising the Medicare eligibility age. But why choose? My bet is that we’re likely to end up with both before too long, accompanied by lots of hand-wringing by Beltway millionaires who will never need these programs about how “painful” the whole thing is.

The whole briefing is only five pages, and is well worth a read.

EDIT 12/17: Title changed slightly due to unintended echo of another article

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