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What You Need to Know About ‘Chained CPI’

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Most people have heard of CPI -- the Consumer Price Index, a commonly cited U.S. government measure of how the cost of living is going up (inflation) or down (deflation). But CPI comes in different flavors, and one, called chained CPI, is having a moment in Washington, as the U.S. Congress tries to pass a tax cut that doesn’t break the bank.

1. What is chained CPI?

It’s a variant of the traditional CPI. Both are reported monthly by the U.S. Labor Department’s Bureau of Labor Statistics, and both track the prices of a "basket" of 80,000 goods and services bought by consumers in urban areas. But chained CPI adjusts for what’s known as substitution bias by recognizing that consumers tend to shift their purchasing behavior as the relative prices of things change. For example, when the price of Granny Smith apples increases, people may buy Gala apples instead. As a result, chained CPI shows a slower pace of price gains, or inflation, than traditional CPI. The gauge’s official name is the Chained Consumer Price Index for All Urban Consumers, or C-CPI-U.

2. What makes it ‘chained’?

A 2010 paper by the Congressional Budget Office explained it this way: "The chained CPI-U provides an unbiased estimate of changes in the cost of living from one month to the next by using market baskets from both months, thus ‘chaining’ the two months together."

3. Why is it in the news?

When elected leaders need to control spending on programs tied to inflation, chained CPI looks more attractive. That’s what happened when President Barack Obama proposed using chained CPI to calculate Social Security cost-of-living adjustments as one way to cut the federal budget deficit. (Congress didn’t take him up on the idea, which he dropped.) This time around, it’s the Republicans who control Congress who are proposing the use of chained CPI, rather than traditional CPI, to make annual adjustments to the income thresholds that kick people into higher tax brackets.

4. How would that work?

This year, the threshold at which a single filer moves from a 25 percent tax bracket to a 28 percent bracket is $91,900. Last year, it was $91,150. It gets adjusted upward to account for inflation, to spare taxpayers from what’s known as bracket creep. If chained CPI were used to calculate the next adjustment, rather than traditional CPI, the 28 percent rate might kick in just a tiny bit earlier -- say, at $92,600 of income, instead of $92,700.

5. What would that accomplish?

Little by little, taxpayer by taxpayer, it would generate more revenue for Uncle Sam. That could help Republican tax legislation meet the deficit-control requirement that it cost no more than $1.5 trillion in revenue over 10 years. Some critics say that use of chained CPI will, over time, amount to a major tax increase. (The Senate’s plan would sunset tax cuts for individuals at the end of 2025, but the use of chained CPI would stay in place.) Also, as during the Obama years, the mention of chained CPI is alarming advocates of Social Security, since its broader adoption would mean benefits growing at a slower pace than they do now.

6. How big a difference does chained CPI make?

Typically, the difference in growth between traditional CPI and chained CPI is a few tenths of a percentage point. Over time, that adds up. Since 2000, CPI-U, the inflation measure used by the government to adjust Social Security benefits, is up 45.7 percent, compared with a 39.7 percent gain for chained CPI.

7. Why the need for new gauges?

Times change. CPI-U -- formally, the Consumer Price Index for All Urban Consumers -- goes back to 1978. The Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, dates back even further, to 1913. Critics say both fail to account for recent changes in how people spend their money. Chained CPI was introduced in 2002. Now there’s talk of a CPI for the elderly, which would give more weight to items such as medical and housing expenses rather than gasoline, electronics or clothing.

The Reference Shelf

— With assistance by Alexandre Tanzi, and Vince Golle

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