Commentary

Chained CPI Won’t Fix Entitlements

In what is being widely hailed as a major compromise, President Barack Obama has embraced the idea of “chained CPI” in his budget. Apparently this idea originated with House Republicans, which provides more proof that not every Republican idea is a good one.

The consumer price index (CPI) measures inflation based on the changing cost of the things we buy over time. The basic CPI measure uses a basket of goods that includes food, housing, clothing and gasoline. In turn, CPI is used to make cost-of-living adjustments for a wide variety of government programs including Social Security, veterans’ benefits and food stamps. The idea being that as the cost of the items in the basket increase, benefits should rise at the same rate in order to keep pace.

However, most economists agree that traditional CPI measures don’t accurately account for the way people really live. For instance, when prices go up, people sometimes settle for cheaper substitutes (i.e. if the price of beef increases, people may eat more chicken instead). Chained CPI attempts to include such behavioral changes in calculating the real level of inflation in the economy.

Chained CPI is liable to achieve far less savings than expected.”

Because of this, chained CPI generally runs about 25 to 30 basis points lower than traditional CPI measures. Therefore, if chained CPI were used to calculate cost of living increases for government programs, it would slow the growth of those programs over time.

This has made the idea popular with Republicans and now, with the Obama administration.

In reality, however, shifting to chained CPI would likely save far less money than commonly believed. For example, the Obama administration proposal would limit the applicability of chained CPI so as to protect lower income and vulnerable populations.

This significantly reduces potential savings. In fact, the Obama administration anticipates only about $130 billion in savings from the change over the next 10 years (though the savings would accumulate in the out years). Given that Social Security alone faces a $22 trillion shortfall (in discounted present value terms over an infinite horizon), that is barely a drop in the bucket of what is needed.

While we should all want the most accurate possible measure of inflation, shifting to chained CPI should not be used as an excuse to shirk the sort of structural reforms necessary to restore Social Security to long-term sustainable solvency.

There can be no serious effort to balance the federal budget and reduce our growing debt without reforming entitlement programs. President Obama deserves credit for being willing to reach across the aisle and accept one such reform proposal, especially in the face of opposition from his own base.

That said, however, chained CPI is liable to achieve far less savings than expected. And those savings will come at the cost of a hidden tax hike for millions of middle-income workers. That seems like a lot of pain for very little gain.