Chained CPI Makes Senses (Update: Maybe Not)

UPDATE: Well, I may partially backtrack on this one quick. I stand by my goal of using an accurate estimator of inflation. I wrote this post assuming that chained CPI is our most accurate estimator for inflation. And it is, except not for seniors. Timothy Noah makes a convincing argument:

For the elderly, spending patterns are unique in one very significant respect: Old people spend a lot more on health care. Yes, they have Medicare. But they also have a lot more trips to the doctor. As a result, the older-65 set spend a much larger portion of their incomes on health-related expenses than the rest of the population. And health inflation, you may have heard, is increasing quite a bit faster than inflation for other goods.

The BLS is aware of that, and has crafted a special CPI just for old people. And guess what? The so-called CPI-E is not only rising faster than the chained CPI; it’s also rising faster than the CPI-W that’s used to calculate benefit increases today. So if a “technical” correction were all that was called for in calculating Social Security, that correction would have to increase benefits, not reduce them.

Well then, maybe benefits have been underestimated for years. I’m going to research more on this, but right now it seems like CPI-E is the way to go for Social Security benefits and chained CPI for taxes, though I don’t think Republicans are going to like the idea of increased benefits and increased taxes very much.

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As journalists across Washington continue to put forth ideas about what could be a part of a fiscal cliff* deal. One possibility that has repeatedly come up is adjusting the way Social Security benefits increase each year to account for inflation. Right now, benefits increase according to CPI-W, but conservatives want to alter the formula by using chained CPI. Dylan Matthews explains the difference between the two better than I can:

Most inflation measures, including CPI-U and CPI-W, track the price of a certain basket of goods. That basket could include, say, a year’s supply of propane. When propane costs go up, CPI-U and CPI-W include that as an increase in the cost of living.

But some people would just stop using propane if its price went up. They’d switch to electric heating, or a geothermal system, or a wood stove. So their actual heating costs wouldn’t go up as much as CPI-U and CPI-W would suggest. Chained CPI attempts to take “substitution effects” like this into account. Thus, its number generally rises more slowly than other metrics.

Thus, chained CPI is an entitlement cut. My take on this has always been that using an accurate estimator of inflation is the ultimate goal. Yes, this would cut benefits and would disproportionately affect seniors who live longer. But, a more accurate way of saying it is that benefits have been growing faster than inflation for decades and seniors that have lived longer have reaped the benefits. This should be something we are looking to correct. Continue reading “Chained CPI Makes Senses (Update: Maybe Not)”