Multiple Budget Functions
Use an Alternative Measure of Inflation to Index Social Security and Other Mandatory Programs
CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.
|Billions of Dollars
|Change in Outlays
|Other benefit programs with COLAsa
|Effects on SNAP from interactions with COLA programsb
|Other federal spendingc
|Change in Revenuesd
|Decrease in the Deficit
Sources: Congressional Budget Office; staff of the Joint Committee on Taxation.
This option would take effect in January 2018.
This estimate does not include the effects of using the chained consumer price index for parameters in the tax code.
COLA = cost-of-living adjustment; SNAP = Supplemental Nutrition Assistance Program; * = between –$50 million and $50 million.
a. Other benefit programs with COLAs include civil service retirement, military retirement, Supplemental Security Income, veterans’ pensions and compensation, and other retirement programs whose COLAs are linked directly to those for Social Security or civil service retirement.
b. The policy change would reduce payments from other federal programs to people who also receive benefits from SNAP. Because SNAP benefits are based on a formula that considers such income, a decrease in those other payments would lead to an increase in SNAP benefits.
c. Other federal spending includes changes to benefits and various aspects (eligibility thresholds, funding levels, and payment rates, for instance) of other federal programs, such as those providing Pell grants and student loans, SNAP, child nutrition programs, and programs (other than health programs) linked to the federal poverty guidelines. (The changes in spending on SNAP included here are those besides the changes in benefits that result from interactions with COLA programs.)
d. The effects on revenues include changes in the revenue portion of refundable tax credits for health insurance purchased through the marketplaces established under the Affordable Care Act, as well as shifts in taxable compensation that would result from changes in the take-up of employment-based insurance.
Cost-of-living adjustments (COLAs) for Social Security and many other parameters of federal programs are indexed to increases in traditional measures of the consumer price index (CPI). The CPI measures overall inflation and is calculated by the Bureau of Labor Statistics (BLS). In addition to the traditional measures of the CPI, that agency computes another measure of inflation—the chained CPI—designed to account for changes in spending patterns and to eliminate several types of statistical biases that exist in the traditional CPI measures. (Nonetheless, the chained CPI does not resolve all statistical issues with traditional CPI measures.)
Beginning in 2018, this option would use the chained CPI for indexing COLAs for Social Security and parameters of other programs. The chained CPI has grown an average of about 0.25 percentage points more slowly per year over the past decade than the traditional CPI measures have, and the Congressional Budget Office expects that gap to persist. Therefore, the option would reduce federal spending, and savings would grow each year as the effects of the change compounded. Outlays would be reduced by $182 billion through 2026, CBO estimates, and the net effect on the deficit would be about the same. (This option would not change the measure of inflation used to index parameters of the tax code, as would be done in the related option cited below; the small revenue effects estimated here stem from changes in the revenue portion of refundable tax credits for health insurance purchased through the marketplaces established under the Affordable Care Act, as well as shifts in taxable compensation that would result from changes in the take-up of employment-based insurance.)
COLAs for Social Security and the pensions that the government pays to retired federal civilian employees and military personnel are linked to the CPI, as are outlays for veterans’ pensions and veterans’ disability compensation. In most of those programs, the policy change would not alter benefits when people are first eligible to receive them, either now or in the future, but it would reduce their benefits in later years because the annual COLAs would be smaller, on average. The effect would be greater the longer people received benefits (that is, the more years of the reduced COLAs they experienced). Therefore, the effect would ultimately be especially large for the oldest beneficiaries as well as for some disabled beneficiaries and military retirees, who generally become eligible for annuities before age 62 and thus can receive COLAs for a longer period.
Growth in the CPI also affects spending for Supplemental Security Income, Medicare, Medicaid, the health insurance marketplaces, Pell grants, student loans, the Supplemental Nutrition Assistance Program, child nutrition programs, and other programs. The index is used to calculate various eligibility thresholds, payment rates, and other factors that affect the number of people eligible for those programs and the benefits they receive. Therefore, switching to the chained CPI would reduce spending by both decreasing the number of people eligible for certain programs and reducing the average benefits that those people receive.
One argument for switching to the chained CPI in Social Security and other federal programs is that the chained CPI is generally viewed as a more accurate measure of overall inflation than the traditional CPI measures, for two main reasons. First, the chained CPI more fully accounts for how people tend to respond to price changes. Consumers often lessen the effect of inflation on their standard of living by buying fewer goods or services that have risen in price and by buying more goods or services that have not risen in price or have risen less. Measures of inflation that do not account for such substitution overstate growth in the cost of living—a problem known as substitution bias. BLS’s procedures for calculating the traditional CPI measures account for some types of substitution, but the chained CPI more fully incorporates the effects of changing buying patterns.
A second reason to believe that the chained CPI is a better measure of inflation is that it is largely free of a problem known as small-sample bias. That bias, which is significant in the traditional CPI measures, occurs when certain statistical methods are applied to price data for only a limited number of items in the economy.
One argument against using the chained CPI, and thereby reducing COLAs in Social Security and other federal retirement programs, is that the chained CPI might not accurately measure the growth in prices that Social Security beneficiaries and other retirees face. The elderly tend to spend a larger percentage of their income on items whose prices can rise especially quickly, such as health care. (However, determining how rising health care prices affect the cost of living is problematic because accurately accounting for changes in the quality of health care is challenging.) The possibility that the cost of living may grow faster for the elderly than for the rest of the population is of particular concern because Social Security and pension benefits are the main source of income for many retirees.
Another potential drawback of this option is that a reduction in COLAs would ultimately have larger effects on the oldest beneficiaries and on disabled beneficiaries who received benefits for a longer period. For example, if benefits were adjusted every year by 0.25 percentage points less than the increase in the traditional CPI measures, Social Security beneficiaries who claimed benefits at age 62 would face a reduction in retirement benefits at age 75 of about 3 percent compared with what they would receive under current law, and a reduction at age 95 of about 8 percent. To protect vulnerable people, lawmakers might choose to reduce COLAs only for beneficiaries whose income or benefits were greater than specified amounts. Doing so, however, would reduce the budgetary savings from the option.
Finally, policymakers might prefer to maintain current law because they want benefits to grow faster than the cost of living so that beneficiaries would share in overall economic growth. An alternative option would be to link benefits to wages or gross domestic product. Because those measures generally grow faster than inflation, such a change would increase outlays.