Thursday, July 14, 2011

Chained CPI explained by Kevin Drum

The Chained CPI is a really bad deal for Social Security beneficiaries. Here's Kevin Drum's explanation.:
Economists on both left and right mostly agree that the current standard measure of inflation, CPI-W, slightly overstates the actual growth in the cost of living. The reason is something called "upper level substitution bias," which means that instead of always buying a standard basket of goods and services, people change their buying habits over time as prices change. When the price of hamburger goes up, they eat more chicken. When the price of chicken goes up, they switch back to hamburger.

A version of CPI that takes this into account is called chained CPI, and overall it's considered a more accurate reflection of actual inflation.
But that is actual inflation for everyone. Older people on fixed incomes are effected quite differently from most people being effected by inflation.
Initial Social Security benefits upon retirement are calculated based on wage levels, so they'd be unaffected by a switch to chained CPI. But annual COLA increases would be affected, and they'd be lower than they are now. Michael Hiltzik suggests two reasons this is unfair. First:

It's not at all certain that elderly persons on fixed incomes can make the sort of lifestyle changes contemplated by the chained CPI....That's because a larger portion of seniors' spending is concentrated in medical goods and services, which aren't as amenable to substitution as, say, oranges for apples.

....Indeed, the BLS has recognized that elderly consumers are a special case by developing an experimental CPI, known as the CPI-E, just for those 62 and older. Among other differences, the index overweights medical care as a factor in seniors' spending....The CPI-E rose nearly 7% faster than the standard CPI from 1998 through 2009, according to government estimates. It also tells you why, from the standpoint of seniors' real cost of living, the chained CPI is a rip-off.

No measure of CPI is perfect for everyone: if the price of gasoline is skyrocketing and you have a long commute, then your personal cost of living will rise faster than official inflation figures. Likewise, because healthcare costs are rising faster than most other goods, people with a lot of medical problems face higher inflation than those who are healthier. From a statistical point of view, then, the best you can do is choose a measure of CPI that's most accurate in general.

Still, the CPI-E issue is a serious objection: it applies to a very large group, and it applies to a large group that typically has modest incomes. Ideally, it would be handled by broadening the scope of Medicare, not by deliberately using an innacurate measure of general inflation, but broadening the scope of Medicare is hardly on the table right now. Given that reality, the net result of this change would be to cut Social Security benefits by calculating inflation less accurately for seniors.
The chained CPI is not representative of the income and expenses of people on Social Security. Essentially it is a cut in benefits to people generally who have no way of adjusting for the cut. It is also not needed since Social Security is not in any near term threat of financial shortage. The chained CPI is a solution looking for a problem to solve and it hasn't found it.

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