The Hill | May 9, 2013
Over the last few days, politically driven critics have called on the president to abandon his support for changing the way the government indexes provisions in the budget to inflation by switching to “chained CPI.” Looking beyond politics, we’re here to say that these critics’ arguments are wrong on their merits.
As economists from opposite ends of the political spectrum, we would strongly urge the president and leaders in Congress to continue to support moving to chained CPI, which represents the most accurate available measure of inflation and cost-of-living increases. Switching to this more accurate measure of inflation represents the right technical, fiscal and retirement policy — and policymakers should not delay any further in making this improvement.
From a technical sense, the current CPI — or consumer price index — that is used to index many parts of the budget and tax code is widely understood to overstate inflation. This is because it fails to account for so-called “substitution bias,” in which consumers reallocate their purchases depending on the relative prices of similar goods. For example, if the price of apples goes up, consumers will buy more oranges. However, this behavior is not accounted for in standard CPI measurements.
The Bureau of Labor Statistics, which calculates the CPI, is very aware of this shortcoming, which is why it has developed and refined the chained CPI for more than a decade. The nonpartisan Congressional Budget Office states that the chained CPI “provides an unbiased estimate of changes in the cost of living from one month to the next.”
Some argue that using the chained CPI to index Social Security benefits is inappropriate because it does not reflect inflation for retirees, which critics suggest is higher than it is for working-age adults because of the elderly’s higher rate of spending on healthcare. However, the CBO has said that based on the available research, it is unclear whether the cost of living actually grows at a faster rate for the elderly than for younger people, and that the CPI-E —“E” for “experimental” — which was intended to provide a more accurate measure of inflation for seniors, has several methodological flaws that overstate inflation, including underestimating the rate of improvement in healthcare.
Beyond the technical case for the chained CPI, there is a strong fiscal case. Because current measures currently overstate inflation by about 0.25 percent per year, moving to a more accurate measure would result in real deficit reduction. Measuring inflation more accurately would generate savings from throughout government: about $390 billion in the first decade alone. Roughly one-third of those savings would come from slower growth in Social Security benefits, another third from revenue increases (as certain tax provisions such as the cutoff points of income tax brackets are indexed to inflation) and the remaining savings from a combination of other spending programs and lower interest payments on the debt. Given the very real need to begin to put our debt on a sustainable path, this would be a small but important contribution. The savings would be gradual, with only a small amount in the near term, thus protecting our fragile recovery from immediate austerity.
Finally, switching to chained CPI is the right retirement policy — or rather, a small piece of it. The Social Security program is on a path to exhaust its trust fund. Current projections indicate that this will occur in 2033, threatening cuts for all beneficiaries, including the very rich and the very poor, the very young and the very old, veterans, disabled workers and others. Improving the way we measure inflation won’t prevent the program’s looming insolvency, but it will eliminate a full fifth of the long-term funding gap.
To the extent that the overpayments under the current formula offset the shortcomings of our current retirement system for the lowest-income and most-elderly beneficiaries, a switch to chained CPI can and should be accompanied by targeted policy changes providing benefit enhancements designed to help the affected populations, rather than providing higher-than-justified inflation adjustments for all beneficiaries.
The federal government should not knowingly continue to measure inflation inaccurately, especially given the costs to the budget and to the Social Security program. Changes that cut Social Security benefits are a tough sell for Democrats, and changes that increase revenue are a tough sell for Republicans. But if they cannot even agree to a technical correction to those areas of the budget, how will they be able to make the hard choices to control our debt and reform our government over the long term?
The Hill | April 30, 2013
In his recent blog entry on chained CPI (Chained CPI: Unfair and inaccurate, April 26th), AARP President Robert Romasco highlights his groups opposition to the change, charging that it would be “Unfair and Inaaccurate.” In fact, nothing could be further from the truth.
A coalition of strange bedfellows, including Grover Norquist’s Americans for Tax Reform and Moveon.org, have announced their opposition to this policy, even as many responsible policymakers from both sides of the aisle and at the highest levels of government continue to support it – notably, the president and the Speaker of the House.
It is no surprise that groups from the left and right have mobilized to defend the status quo in order to avoid the tough choices that must accompany any responsible deficit reduction plan. Yet, the resistance to a reform as simple and obvious as using the most accurate measure of inflation for price-indexed provisions in the budget is both astounding and disappointing.
Economists from the left, right, and center are in broad agreement that chained CPI more accurately reflects cost-of-living increases by accounting for the small-sample and substitution biases in the current inflation measure. This view is shared by experts at the non-partisan Congressional Budget Office as well as the experts at Bureau of Labor Statistics who are responsible for measuring inflation. Adopting the chained CPI doesn’t represent a policy change, but rather would best reflect the current intent of the law to index various provisions to inflation.
And while some argue that seniors face faster cost-growth than other populations, there is little evidence of a significant difference when one accounts for the fact that seniors are more likely to own their own homes mortgage free, have different shopping habits than younger populations, are able to take advantage of senior discounts, and receive constantly improving health treatments. Indeed, according to the Congressional Budget Office, “it is unclear, however, whether the cost of living actually grows at a faster rate for the elderly than for younger people.”
Moreover, offering seniors a preferential inflation measure raises more fairness concerns than it answers. If seniors receive a higher inflation measure, should non-seniors on the Social Security program receive a lower measure? Geographic inflation disparities are far larger than alleged age disparities (inflation has averaged 2.7 percent in New York and 1.8 percent in Detroit over the last decade); why protect seniors and not New Yorkers? What about other government programs and tax provisions? Should each be indexed to costs within its population? Or only those backed by powerful interest groups?
Indeed, it would be highly unfair to politicize inflation indexing or to exempt any government program or tax provision from the most accurate available measure of inflation.
More unfair would be ignoring our fiscal and retirement challenges and leaving the job to a future politicians. According to the left-leaning Center on Budget and Policy Priorities, the President’s chained CPI proposal would result in benefit levels 1 to 2 percentage points lower than under current law – and it accompanies the switch with benefit enhancements for the old that actually reduce poverty among that group. By comparison, there is a 25 percent cut scheduled to occur under current law when the trust funds dry up in 2033. The greatest unfairness would be allowing this across-the-board benefit cut to hit every beneficiary regardless of age or income – when this cut could be easily avoided through a balanced package of revenue and benefit adjustments.
Mr. Romasco is right, we need a national conversation on improving retirement security, including how to make Social Security sustainably solvent in order to avoid abrupt benefit cuts and ensure the system is better protecting those who rely on it. Ideally, we’d have this conversation now. However, the overheated reaction to a technical correction in cost of living adjustments suggests that the political system may not be ready to tackle comprehensive Social Security reform. Continuing to index benefits improperly while we wait for this reform to materialize would be a costly mistake that will only make future Social Security changes more painful.
Ed Lorenzen Testimony Before the House Ways and Means Committee's Subcommittee on Social Security: Chained CPI
Los Angeles Times | April 2, 2013
In his March 22 blog post criticizing proposals to switch from the consumer price index to "chained CPI" to determine cost-of-living adjustments for Social Security beneficiaries and other items in the federal budget, Michael Hiltzik claimed that there were "no grounds" for the statement made in a recent paper from the Moment of Truth Project ("Measuring Up, The Case for Chained CPI") that the chained CPI provides a more accurate measure of inflation than the measure currently used.
In fact, experts across the ideological spectrum agree that the chained CPI is indeed more accurate. In his 2005 book "The Plot Against Social Security," Hiltzik listed various proposals for reforming Social Security, among them chained CPI. He wrote, "Many economists maintain that CPI consistently overstates inflation ... because it doesn't account for so-called substitution effects." Hiltzik doesn't explicitly endorse the proposal, but this is certainly a far cry from his objection that there are "no grounds" for the claim that chained CPI is a more accurate measure of inflation.
Advocates for using chained CPI to more accurately index government programs to inflation include Austan Goolsbee, who served as chairman of the president's Council of Economic Advisors under President Obama, and Michael Boskin, who held the same position under the President George H.W. Bush. Their view is shared by the overwhelming majority of economists. A report by the nonpartisan Congressional Budget Office stated that the chained CPI "provides an unbiased estimate of changes in the cost of living from one month to the next." Two of the most respected and prominent defenders of Social Security, the late Sen. Daniel Patrick Moynihan (D-N.Y.) and the late Robert Ball, the longest-serving Social Security commissioner, who founded the National Academy of Social Insurance, both supported the use of chained CPI to more accurately achieve the goal of providing inflation protection for seniors and disabled beneficiaries.
The Bureau of Labor Statistics has noted the shortcomings of the current inflation indexing and specifically designed the chained CPI to be a closer approximation to a cost-of-living index. The bureau has developed and refined the chained CPI over more than a decade.
The government indexes benefit programs such as Social Security as well as provisions in the tax code to ensure they keep pace with inflation. Using a more accurate measure of inflation is not a benefit cut, but rather ensures that the benefits increase by the proper amount to achieve the desired policy goal. This change does not single out Social Security, as Hiltzik implies, but would apply to provisions throughout the federal budget. Social Security accounts for slightly more than one-third of the $390 billion in total savings over the next decade that would result from switching to chained CPI, with a similar amount of savings from revenue and the remainder from other government programs indexed to inflation along with interest savings.
To the extent that the overpayments under the current formula provide important help to certain low-income and elderly individuals, a switch to the chained CPI can and should be accompanied by targeted policy changes providing benefit enhancements designed to help the affected populations rather than providing higher-than-justified inflation adjustments for everyone. Every significant bipartisan deficit reduction effort, including the Simpson-Bowles plan, the Domenici-Rivlin plan and the negotiations between Obama and House Speaker John Boehner (R-Ohio) has proposed using chained CPI to index spending programs and the tax code, with a portion of the savings used to provide enhancements for low-income, elderly and other vulnerable populations.
Addressing our fiscal challenges will require many tough choices and policy changes, but the chained CPI represents neither. Eliminating the unjustified increases in spending and reductions in revenue that have resulted from using an inaccurate measure of inflation should be at the top of the list for any deficit reduction plan.
This report was originally published 05/11/2011 and has been updated on 12/12/2012 and again on 3/19/2013.
The Government We Deserve | January 23, 2013
“We must act, knowing that our work will be imperfect,” Barack Obama proclaimed in his second inaugural address. Interestingly, the Washington Post blazoned its front page with the first three words without noting the succeeding dependent clause. Yet within this clause, I believe, lies the means by which the president—and Congress—and we—can move past so many of our conflicts and face up to the problems that confront us. The solution lies not in acting, but in recognizing the imperfection of what we do. If our budgets are to be vehicles for change, then we cannot enact so many laws as if the priorities of one time and place must endure forever.
More than ever before, our recent fights carry with them the implication that victory must be complete and total, setting in stone the institutions that will rule over our successors for decades and centuries to come. “We must act,” each political party seems to say, “as if our work will be perfect, else our opponents may someday slow down or even reverse our course.” Permanent monuments must be made to some liberal or conservative agenda, regardless of whether that monument rests upon unstable ground, employs an architecture glued together from incongruous designs, or fails to leave room for the improvements that only future knowledge may reveal.
Today, if we favor Social Security, it must be maintained permanently in its ancient design. For all generations of ever-expanding life expectancies, we must allow beneficiaries to retire as early as 65, or, when feeling temporarily richer, at 62. We must even accept its 1940s stereotype of the two-parent family, with abandoned mothers required to pay taxes to support spousal benefits for which they are ineligible. Similarly, if we favor less government, we can’t just work toward that goal by reducing spending. No, we have to create permanent tax cuts even if that means running economically disastrous deficits.
If we favor helping the poor, then we can never give up support for benefits like SNAP or food stamps. These programs must be etched in the law as superior to any alternative use of those funds, including ones that might provide better opportunities to people in need. If we subsidize an industry, whether oil or alternative fuel or agriculture or manufacturing, then we must enshrine that subsidy in the tax code.
Now, of course, there’s good reason for using legislation to try to provide some certainty or security. With perfect foreknowledge, we can plan for the future. But what if that future remains uncertain? Planning for it then requires creating a way to respond to its surprises, good and bad.
Unfortunately, we’ve gone long past the point where our federal budget could be flexible. A fiscal democracy index I developed with Tim Roeper shows that the combination of entitlement growth and low revenues means that today most revenues are already committed to permanent spending programs. Almost every congressional decision to adjust national priorities has to be paid for out of a deficit, or by overturning some past “permanent” enactment.
Earlier, before entitlements became so prevalent and dominant, spending was largely discretionary. Congress also felt that we should pay our bills on time, so it didn’t finance tax cuts for today’s generations by passing those liabilities onto future generations. Though many programs survived for decades, most still had to receive new votes of support. Even more important, almost none had any built-in growth. That made it easy to let some ideas languish as others came into prominence, leaving room for new choices or reconsideration over time.
Compromise is much easier when one side or the other isn’t forced into reneging on past promises to the public. It’s easier when it’s possible down the road to proceed on the same course, pursue the same objective via a different course, or decide on both a new objective and course. It’s easier when we’re not asking our opponents to keep funding some permanent monument we want erected to ourselves.
“But we have always understood that when times change, so must we; that fidelity to our founding principles requires new responses to new challenges…We understand that outworn programs are inadequate to the needs of our time…Let us answer the call of history, and carry into an uncertain future that precious light of freedom.” (Barack Obama, January 21, 2013; emphasis mine).