Testimony on Using the Chained CPI to Index Social Security, Other Federal Programs, and the Tax Code for Inflation

Testimony by Jeffrey Kling, Associate Director for Economic Analysis, before the Subcommittee on Social Security, Committee on Ways and Means, U.S. House of Representatives

Cost-of-living adjustments (COLAs) for Social Security benefits and other parameters of many federal programs and the tax code are currently indexed to increases in the traditional consumer price index (CPI), a measure of overall inflation calculated by the Bureau of Labor Statistics (BLS). According to many analysts, however, the CPI overstates increases in the cost of living because it does not fully account for the fact that consumers generally adjust their spending patterns as some prices change relative to other prices and because of a statistical bias related to the limited amount of price data that BLS can collect. One option for lawmakers would be to link federal benefit programs and tax provisions to another measure of inflation—the chained CPI—that is designed to account fully for changes in spending patterns and that does not have the same statistical bias.

The chained CPI grows more slowly than the traditional CPI does: an average of about 0.25 percentage points more slowly per year over the past decade. As a result, using that measure to index benefit programs would reduce federal spending for Social Security, federal employees’ pensions, Medicare, Medicaid, and various other programs. For example, if such a proposal took effect next year, Social Security benefits would be roughly $30 a month lower, on average, by 2023 than they would be under current law, representing a reduction of about 2 percent of average benefits. (Depending on when they started receiving benefits, some people would see a greater percentage reduction and others a smaller one.) In addition, indexing tax provisions with the chained CPI would increase revenues.

If all uses of the traditional CPI in mandatory programs and the tax code were switched to the chained CPI starting in calendar year 2014, mandatory spending would be reduced by a total of $216 billion between fiscal years 2014 and 2023, and federal revenues would be increased by $124 billion. (The President’s budget for fiscal year 2014 includes a related but less comprehensive option that would use the chained CPI for Social Security and some other spending programs as well as for the tax system. CBO is currently reviewing that and other proposals in the President’s budget.)

Although many analysts consider the chained CPI to be a more accurate measure of the cost of living than the traditional CPI, using it for indexing could have disadvantages. The values of the chained CPI are revised over a period of several years, so affected programs and the tax code would have to be indexed to a preliminary estimate of the chained CPI that is subject to estimation error. Also, the chained CPI may understate growth in the cost of living for some groups. For instance, some evidence indicates that the cost of living grows at a faster rate for the elderly than for younger people, in part because changes in health care prices play a disproportionate role in older people’s cost of living. However, determining the impact of rising health care prices on the cost of someone’s standard of living is problematic because it is difficult to measure the prices that individuals actually pay and to accurately account for changes in the quality of health care.