House Ways and Means Looks at the Chained CPI

Today, the House Ways and Means Subcommittee on Social Security held a hearing on using the chained CPI to determine Social Security cost-of-living adjustments (COLAs). Testifying before the subcommittee was CRFB Senior Advisor and Executive Director of the Moment of Truth Project Ed Lorenzen. In his testimony, Lorenzen highlighted the merits of switching to the chained CPI as a more accurate measure of inflation.

Lorenzen began by explaining the reason behind the development of the chained CPI, which can be traced back to a blue ribbon commission dubbed the “Boskin Commission” for its chair economist Michael Boskin. The Boskin Commission found several issues with substitution bias in the current CPI. As a result, the Bureau of Labor Statistics implemented a number of changes that have resulted in a lower CPI, but has been unable to address the issue of upper level substitution (consumer substitution between categories) without a legislative fix.

Implementation of the geometric mean has reduced the annual growth rate of the CPI by approximately 0.3 percentage points, with other changes reducing CPI further. The cumulative impact of these changes on the reported CPI is approximately 0.35 percentage points, which is slightly greater than the impact of switching to the chained CPI. Yet these changes implemented by the BLS were automatically applied to the indexation of government programs and the tax code with little notice or controversy.

Lorenzen, who also served as staff on the Fiscal Commission, discussed the background behind the chained CPI’s inclusion in the Fiscal Commission’s 2010 report. He noted that the idea to use the chained CPI emerged early on as an area of bipartisan agreement:

Switching to the chained CPI was an early area of general consensus as Commission members began to discuss specific policy options. It was suggested as an option to reduce the Social Security shortfall by one of the Democratic Members of the mandatory spending working groups, and had previously been included in bipartisan tax reform legislation introduced by Republican Commission member Senator Judd Gregg. Commission members emphasized the importance of making this change as a technical improvement to more accurately index programs for inflation and believed that, in order to be credible, the change must be applied to all provisions in the budget (both the spending and revenue sides) that are indexed to inflation.

In addition to discussing the background of the chained CPI, Lorenzen addressed some of the concerns critics of the policy have had. Specifically, he explained the chained CPI is actually distributionally neutral and, as we explained earlier this week, Social Security benefits under the chained CPI would be 25 percent higher than under the payable benefit scenario in 2033. However, he did identify various targeted policies that could be implemented to protect certain vulnerable populations.

Looking specifically at proposals to switch to the chained CPI in isolation, any undesirable effects of the chained CPI on certain vulnerable populations can be addressed through small policy changes targeted to those populations rather than continuing to provide higher than justified inflation adjustments for all individuals regardless of income at a cost $340 billion over ten years. For example, the Fiscal Commission recommended instituting a flat dollar benefit bump-up equal to five percent of the average benefit.

The hearing included additional testimonies by Erica L. Groshen, Commissioner of the Bureau of Labor Statistics; Dr. Jeffrey Kling, Associate Director for Economic Analysis, Congressional Budget Office; Nancy Altman, Co-Chair of the Strengthen Social Security Coalition; and Charles Blahous, Social Security and Medicare Trustee.

Some commentators have claimed that the CPI-E is more accurate than the chained CPI in calculating seniors’ cost of living. Commissioner Goshen warned Members that the CPI-E is still an experimental index, and could not be immediately implemented. Her statements echoed BLS’s earlier warnings that if lawmakers consider the CPI-E, “any conclusions drawn from the data should be interpreted with caution.” In Dr. Kling’s testimony, he noted:

All versions of the CPI overstate growth in the cost of living, with the overstatement being especially large for the CPI-E because of the large weight on health care in that index.

Blahous’s testimony highlighted the potential benefits that adopting the chained CPI would have for the Social Security program. He described the upcoming funding shortfall in some detail, arguing that the chained CPI would have a positive impact on the program’s finances and generational program equity. However, he strongly cautioned that adjusting the index will not come close to ensuring Social Security’s long-term solvency, and he encouraged lawmakers to consider the change as part of a comprehensive reform of our nation’s entitlement programs.

This is the first in a series of hearings the Ways and Means committee will hold on bipartisan entitlement reforms. As lawmakers look to reach bipartisan agreement on these important reforms, today’s hearing demonstrated the chained CPI offers an opportunity for lawmakers to not only enact sound policy to more accurately measure inflation, but provide much needed deficit reduction as well.