Following is an excerpt from a recent Congressional Research Service report examining the way inflation is measured for purposes of adjusting federal retirement and other benefits, a topic under discussion for possible change.
Recent deficit reduction commissions, including the National Commission on Fiscal Responsibility and Reform, have recommended using an alternative measure of consumer price change to make inflation adjustments to federal programs government-wide. The proposal would change, for example, the way the Social Security cost-of-living adjustment (COLA) is computed, as well as COLAs under other federal programs. Rather than using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to compute the Social Security COLA, the proposal calls for the Social Security COLA to be based on the Chained Consumer Price Index for All Urban Consumers (Chained CPI-U or C-CPI-U).
In general, the goal of the Chained CPI-U is to more accurately reflect how consumers change their buying habits in response to changes in prices. The Chained CPI-U typically has risen more slowly than either the CPI-W or the “regular” CPI-U. Supporters of the proposal argue that the CPI-W overstates inflation and, therefore, overestimates how much money is needed for Social Security beneficiaries to maintain their standard of living. Opponents of the proposal, however, view using the Chained CPI-U to adjust Social Security benefits for inflation as a backdoor way of reducing benefits. They maintain that the market basket of goods and services purchased by the elderly is different from that of the general population around which the CPI is constructed. It is more heavily weighted with healthcare expenditures, which rise notably faster than the overall CPI, and thus they contend that the cost of living for the elderly is higher than reflected by the overall CPI. For this reason, some policymakers support using the experimental Consumer Price Index for the Elderly (CPI-E) to compute the Social Security COLA. The current discussion of a potential change in the way the Social Security COLA is computed has raised questions about indexing provisions in other federal entitlement programs.
The U.S. Bureau of Labor Statistics (BLS) publishes the CPI-W and the CPI-U whose month-to-month fluctuations reflect changes in the prices faced by consumers. More specifically, the change in the indexes is the average change in the retail price of a market basket composed of more than 80,000 items purchased by consumers at outlets (e.g., grocery stores and gasoline stations) in 87 urban areas across the nation. Changes in the prices of items in each area are averaged together using weights that reflect the items’ importance in the spending of the CPI-W population and the CPI-U population. The national CPI-W and CPI-U are calculated by combining the local area data for all items in the market basket to obtain a U.S. city average. The rates of change in consumer prices as measured by the national CPI-W for all items and national CPI-U for all items have differed only slightly over time.8 In addition to their use in calculating constant-dollar estimates of other economic indictors (e.g., earnings), the national CPI-W and CPI-U as well as indexes for specific goods and services (e.g., medical care) are used for inflation indexing by the federal government. The percentage change in the national CPI-W (all items) is the basis for determining the annual COLA of Social Security benefits and the national CPI-U (all items) is the basis for determining certain features of the Earned Income Tax Credit, for example.9 In addition, the percentage change in the CPI-U for specific groups of items is used to inflation-adjust various features of other federal programs. For example, per-meal subsidies paid to schools under child nutrition programs are tied to changes in the CPI-U “food away from home” index (which is a combination of indexes for full-service meals and snacks, limited-service meals and snacks, food at employee sites and schools, food from vending machines and mobile vendors, and other food away from home).
As part of its ongoing efforts to develop an index that more accurately measures changes in the cost of living, BLS developed the Chained Consumer Price Index for All Urban Consumers (CCPI- U). The population of the C-CPI-U and CPI-U are the same. The prices used to calculate the C-CPI-U, CPI-U, and CPI-W are the same. However, the formula for calculating the C-CPI-U better accounts for the ability of consumers to maintain their standard of living in the face of an increase in prices overall by changing their spending pattern toward items whose prices have increased more slowly and away from items whose prices have increased more quickly.
Although the C-CPI-U was first published in 2002, the modified measure has not replaced the CPI-U or CPI-W and no federal program has used the C-CPI-U to date. Some members of the public policy community interested in curtailing growth of the U.S. budget deficit have proposed switching inflation-indexed federal programs and income tax provisions to the C-CPI-U, however. Because the C-CPI-U typically has risen more slowly than either the CPI-W and CPI-U, changing the basis for indexation could substantially lower outlays and raise revenues. But, the proposal to switch from the CPI-W to the C-CPI-U has prompted concern in some quarters about the ability of Social Security beneficiaries to maintain their standard of living.
Some have suggested instead changing to the experimental index for those at least 62 years old (CPI-E) in the arguable belief that it better reflects the elderly population’s experience with inflation (i.e., this population’s above-average spending on health care services whose prices have increased faster than overall prices). The most recognized effect of inflation adjustments is on benefit levels. For example, monthly cash benefits, such as Social Security and Supplemental Security Income benefits, increase when a COLA is paid. Other types of benefits are indexed as well. Non-cash benefits provided under the Supplemental Nutrition Assistance Program (SNAP), for example, are indexed to reflect food-price inflation. Coverage amounts under Medicare’s standard outpatient prescription drug benefit (Part D) are adjusted for inflation.
Inflation adjustments also affect entitlement programs in ways that are less well known, from federal payments to providers to program eligibility requirements. For example, when a Social Security COLA is paid, the amount of wages subject to the Social Security payroll tax increases. Indexing affects the number of Medicare beneficiaries subject to higher income-related Part B and Part D premiums, as well as the amount of Medicare payments to providers. In another example, indexing affects cost-sharing amounts paid by Medicaid beneficiaries for prescribed drugs and for non-emergency services provided in an emergency room. Per-meal subsidies paid to schools, for example, under the National School Lunch program are indexed. Finally, indexing affects eligibility criteria for some programs, including Medicaid and the child tax credit.
Generally, switching to the C-CPI-U to compute COLAs and index other elements of federal entitlement programs is considered as a cost-saving measure in an effort to reduce federal budget deficits. For example, CBO estimates that switching to the C-CPI-U to compute Social Security COLAs would reduce federal outlays by about $27 billion over five years (2012-2016) and by $112 billion over 10 years (2012-2021). If applied on a government-wide basis, however, switching to the C-CPI-U could increase program costs in some cases. Under Medicare, for example, cost-sharing amounts for outpatient drugs paid by low-income beneficiaries who receive subsidies under Part D are indexed annually to the CPI-U under current law. Because the Chained CPI-U grows more slowly than the CPI-U when consumer prices increase, indexing cost-sharing amounts to the Chained CPI-U would result in an increase in federal Medicare spending.
Similarly, consider the refundable portion of the child tax credit (referred to as the additional child tax credit or ACTC). Taxpayers must have earnings that exceed the refundability threshold to claim the ACTC. The lower the threshold, the greater the number of low-income taxpayers who become eligible for the refundable child tax credit. Indexing the refundability threshold to a lower inflation index would expand the availability of the refundable child tax credit.
A further consideration with respect to switching to a chain weighted CPI on a government-wide basis is that BLS has developed a chain weighted CPI for the CPI-U series only. BLS has not, for example, developed a chain weighted CPI for the CPI-W series, which is used to determine Social Security COLAs and COLAs under other federal programs. As such, some proposals call for using the Chained CPI-U in place of both the CPI-U and the CPI-W where those indexes are used for inflation adjustments under current law. It could be argued that it would be more consistent with current law to apply the chained CPI concept to the CPI-W series and use that index (rather than the Chained CPI-U) to compute Social Security COLAs and COLAs under other federal programs that use the CPI-W. Switching to a new measure of consumer price change (such as the Chained CPI-U) to index various provisions within complex federal programs would require careful consideration with respect to implementation to avoid inconsistencies within and across federal programs.
As CBO points out, another consideration with switching to the Chained CPI-U to compute COLAs and index other provisions of federal entitlement programs is that BLS publishes the index initially as a preliminary value and then revises it over a period of more than two years. As a result, federal programs would be indexed to a preliminary estimate of the Chained CPI-U that is subject to estimation error. CBO further points out that the Chained CPI-U “may understate growth in the cost of living for some groups, such as older people.”
