A report for Congress has laid out advantages and disadvantages of changing the inflation index used for annually increasing a range of federal benefit programs, including federal retirement benefits and Social Security payments.
The Obama administration in its recent budget proposal endorsed switching to the "chained" consumer price index, estimating that the change would save $230 billion across all affected programs over 10 years. An estimate from a federal employee organization put the effect on federal retirement benefits at $15 billion over that time.
The recommendation, which is politically controversial, follows similar proposals from a variety of deficit reduction advocates in recent years, most notably the Simpson-Bowles Commission.
A report on the issue done by the Congressional Research Service does not take sides but rather examines arguments for and against such a change.
It notes that the Labor Department’s Bureau of Labor Statistics has been compiling the chained CPI—technically dubbed the C-CPI-U—since 2002 as a supplemental way of looking at inflation. Benefit programs are tied to what is called the CPI-W, and federal tax brackets are tied to yet a third measure, the CPI-U.
Said the report, "The aim of the C-CPI-U is to produce a measure of change in consumer prices that is free of substitution bias. One of the difficulties in estimating cost-of-living changes is that consumers often alter their buying patterns in response to changing relative prices. In other words, consumers tend to buy more of the goods and services whose prices are rising slower than average and fewer of the goods and services whose prices are rising faster than average. Substitution is believed to insulate consumers from the full effect of rising prices on maintaining their standard of living.
"Because the CPI-W and CPI-U do not entirely account for substitution, they overstate the impact of inflation on consumer well-being. As a result of better reflecting consumer substitution, the C-CPI-U has typically increased to a lesser extent than either the CPI-U or CPI-W."
Estimates generally range from 0.3 to 0.5 percent lower.
One other issue is that the C-CPI-U is subject to two revisions after its first release. "If the two indexes were replaced by the C-CPI-U, cost-of-living adjustments would either have to wait until the final number was available or rely on preliminary estimates that could change up to two years after the fact," said the report.
"Whether the preliminary C-CPI-U estimates might be attractive alternatives to using the final estimate depends on whether they are biased relative to the final number or if the revisions tend to be significant. If the final index tends to rise more than the preliminary estimates, it might make their use unpopular with those who would be affected. More specifically, because increases in the C-CPI-U have tended to be smaller than in either the CPI-W or CPI-U, some Social Security beneficiaries, taxpayers, and individuals whose eligibility for federal programs is based on the poverty threshold (e.g., food stamps) might oppose switching to the C-CPI-U."