Editorial Board

Chained CPI Switch Is a Slam Dunk, Even in Election Year

Sadly, Congress and the White House seem incapable of agreeing on substantive measures to tackle the $10.4 trillion mountain of U.S. debt.

But there is one long-overdue piece of important business that can and should get done: The adoption of a more accurate gauge of U.S. inflation that would yield immediate savings and help put the economy on firmer ground. The fix has already been endorsed by lawmakers in both parties, the Obama administration, many economists and a series of bipartisan deficit-reduction panels. Best of all, it would help shore up Social Security. Trustees for the retirement fund on April 23 projected it would run dry in 2033, three years earlier than last year’s forecast.

It has been widely recognized for almost two decades that the current measure, the consumer price index, contains several biases that cause it to overstate inflation anywhere from 0.3 percentage point to 0.8 percentage point, depending on which expert you talk to. The miscalculation has damaging consequences for the U.S. economy. The CPI is the benchmark that determines cost-of-living adjustments for a wide range of government programs, including Social Security and federal employee pensions. It also is used to peg income-tax brackets, exemptions, deductions and credits.

Consumer Behavior

A more accurate measure has long been available in the form of the chained CPI, which corrects for one of the most prominent distortions -- the failure to track changes in consumer behavior. To calculate the standard CPI, Bureau of Labor Statistics employees shop for a market basket of 80,000 goods and services that are weighted to reflect consumer-spending patterns. Since 2002, the BLS has also compiled the chained CPI, a more exact measure that accounts for the substitutions consumers make when a product’s price goes up. A shopper might respond to an increase in the cost of Granny Smith apples, for example, by switching to lower-cost Red Delicious, a process known as lower-level substitution. Or a consumer might react to a price increase in one item by switching to another category altogether, say less-expensive oranges instead of pricier apples -- called upper-level substitution.

While the standard CPI largely maintains the same basket of goods regardless of price changes, the alternative measure more accurately models substitution behavior by “chaining” two consecutive months of price data and adjusting the weights to account for a decrease in purchases of the more expensive product and increased purchases of the lower-cost substitute (more oranges, fewer apples).

On average, the BLS’s chained CPI has been 0.25 percentage point to 0.35 percentage point lower than the standard CPI. That doesn’t sound like much, yet switching to the alternate measure would produce as much as $300 billion in savings and revenue within a decade. The Congressional Budget Office has estimated that using the chained CPI to set cost-of-living increases for Social Security alone would save $112 billion from 2012 to 2021. An additional $33 billion could be saved by applying the measure to other federal spending.

Those estimates alone should make the chained CPI a slam dunk. The effect on tax collection would also be dramatic. The switch would mean smaller annual adjustments to tax thresholds. Many people’s wages would rise faster than the new inflation index, pushing them into higher tax brackets and producing as much as $90 billion in new revenue over 10 years. It would also reduce interest payments on the debt by about $44 billion.

Political Cover

Making this change wouldn’t require an extraordinary act of political courage. The adoption of the chained CPI has been an element of every serious bipartisan deficit-reduction plan of recent years, including those of Alan Simpson and Erskine Bowles, Alice M. Rivlin and Pete V. Domenici, as well as the “Gang of Six” led by Senators Mark Warner and Saxby Chambliss. It also was among the ideas very nearly agreed on during last summer’s debt-limit negotiations between the White House and House Republicans.

Moreover, it has found favor with think tanks of the left, such as the Center for American Progress, that usually oppose anything resembling a benefit cut, and those of the right, such as the Heritage Foundation, which typically bristle at proposals that can be construed as tax increases.

AARP and other groups have raised legitimate concerns that the new inflation measure would reduce future Social Security payouts. Those concerns could be addressed by improving benefits for low-income seniors. In any case, the Social Security trustees’ report this week provides ample evidence that a quick correction is needed now.

Refining an economic gauge that is as fundamental as the CPI is simple common sense. It is understandable that a vigorous debate has erupted over just how much inflation -- if any -- is desirable or tolerable in our economy. But that discussion is entirely separate from the important step we are recommending: Let’s make sure the measure we use is accurate.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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