In the Nation's Interest

Budget News: Administration Will Drop Chained CPI Proposal

By Joseph Minarik

Just about every news vehicle reported this morning that President Obama will drop his budget proposal to convert both income tax and Social Security inflation indexation to the “chained CPI” from the conventional index that has been used for the history of those provisions.  To some, this seems to be tragic news.  I would suggest that we calm down a bit.

First, some background:  If you missed it, the idea of switching inflation indexation to the chained CPI has a long history.  It was included in the 1997 deal for what became the Balanced Budget Act up until the very last minute.  (Unexpectedly, but at the request of both the Administration and the Congressional negotiators, the Congressional Budget Office (CBO) announced that they would reduce the interest rates in their economic forecast if the Congress acted on the deal.  The lower interest rates would save future debt-service costs.  The negotiators then merrily threw over the side the most unattractive deficit-reduction steps – including the chained CPI – precisely equal in savings to the amount of the reduction of interest costs from the new CBO interest rates.  Spoiler alert:  The budget would have balanced even without the 1997 deal.)

As you probably have heard before, the chained CPI is a surely imperfect attempt to adjust the measured change in the cost of living to take account of the ability of consumers to adjust their spending when prices change.  Oversimplifying, if the price of apples increases disproportionately, the chained CPI considers that rather than mindlessly going on buying the more-expensive apples, consumers might switch to oranges instead.

Thus, increases in the chained CPI are unambiguously smaller than increases in the standard index.  Recent proposals to switch to the chained CPI would both increase tax revenue and reduce spending.  On the tax side, the chained CPI would result in smaller increases in personal exemptions, standard deductions, tax-rate-bracket boundaries, and other parameters.  On spending, the chained CPI would reduce the rate of growth of Social Security benefits, and would be applied to other indexed benefits as well.

You will hear self-styled principled arguments against the conversion to the chained CPI.  Some people complain that the measurement of consumer purchasing changes for relative price changes is inexact.  That is true.  The underlying, basic index is inexact, too.  Some complain that the tax consequence of switching to the chained CPI has a finite maximum amount.  Once a taxpayer is in the highest tax bracket, the additional tax due from an additional dollar of income is not increased by the switch to the chained CPI.  Accordingly, this group says that the conversion to the new index is not sufficiently “progressive.”  However, if you accept the chained CPI as on principle a more appropriate price index, then your actual concern about progressivity is not the chained CPI, but rather the underlying law.

There is one concern about the chained CPI that should be kept in mind, although that again is an interaction with underlying law, not inflation indexation alone.  Slower inflation indexation – whatever your thoughts on its accuracy – will have the greatest dollar effects on the oldest retirees, cumulatively over long periods of time.  The oldest retirees, given longevity patterns, are widows – and long-lived widows are often the horror stories of income adequacy under the Social Security system we have today.  For that reason, plans to deal comprehensively with Social Security’s long-term finances almost always convert to the chained CPI but also raise benefits for low-wage and for long-lived retirees (see the Domenici-Rivlin Debt Reduction Task Force for an example). But when looking in isolation at one proposal in a budget, such important details tend to get lost in the background noise.

Which takes us back to the President’s budget.  Let’s be honest with ourselves:  This episode is all about politics.

Ask Democrats what got us to this point (we’ll hear from the Republicans in a moment), and they will tell you that years ago, Republicans asked President Obama to include conversion to the chained CPI in his budget as a sign of good faith to justify starting a budget negotiation.  So the President proposed the chained CPI – and his thanks from the Republicans was to rush out to the hinterlands telling the elderly that Democrats wanted to throw them under the bus and cut their Social Security benefits.  Now, in an election year, Democrats say that they don’t want to self-immolate yet another time.

Of course, Republicans say that the Democrats’ story is all wrong, that the Democrats refused to touch other entitlement programs (including Medicare) and insisted on big tax increases.  And if you have enough time, we can keep going around this tree and engage on whether Adam or Eve was at fault in the Garden of Eden.

So instead, let’s save some time.  It is not worth getting upset as though the President’s dropping the chained CPI from his budget is going to prevent a big budget deal this year.  No big budget deal was going to happen this year anyway, unless lightning should strike.  And dropping the chained CPI from the President’s budget probably won’t change the odds of lightning striking, either.

If lightning does strike, for whatever reason that may occur, the chained CPI will be a part of the deal – even though it (reportedly) will not appear in the President’s budget – because given all of the alternatives, it is one of the relatively most productive and least painful ways to cut the deficit.  (There is no easy money lying on the sidewalk; if there were, it would have been picked up a long time ago.)  And the deal will be big, and sloppy, and messy, and it will include many things that purists won’t like.  But the important thing about that deal (echoing some of the best advice I got upon first attacking my doctoral dissertation 40 years ago) will not be that it’s right, but that it gets writ.

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