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Fri December 14, 2012
Inflation Index Fix Could Cut Federal Deficit
Originally published on Fri December 14, 2012 8:13 am
The Consumer Price Index is one of the most familiar measures in economics and politics. But some in Washington want to change the way the index is calculated to better reflect people's shopping habits.
While the proposed change is described as a technical fix, it could also cut the federal deficit by hundreds of billions of dollars over the next decade.
It's a small number, but the inflation measure can make big waves. It's used to adjust Social Security and other retirement benefits. And like any government statistic with the potential to move markets, it's a closely guarded secret until the official announcement.
"The areas where the people that produce the CPI work are certainly sealed off from everyone else during this period," says John Greenlees, who heads the Division of Price and Index Number Research for the government.
The Bureau of Labor Statistics' latest announcement, on Friday morning, showed consumer prices inched down 0.3 percent in November — helped in part by a sharp drop in the cost of gasoline.
To come up with this little number, Greenlees says, an army of consumer lookouts roam the country looking for changing prices.
"They visit stores and doctor's offices and barber shops and hospitals, collecting prices throughout the month," he says.
These part-time government shoppers compare the same basket of goods and services every month, to see which prices have gone up and which have gone down, and they crunch those numbers together to get the Consumer Price Index.
The only problem, say critics, is that's not how consumers actually shop.
"If the price of turkey goes up and I buy more ham, or if the price of oranges goes up and so I buy more apples, that's not accounted for in the current price index," says Marc Goldwein of the nonpartisan, nonprofit Committee for a Responsible Federal Budget. "It thinks I continue to buy those oranges, no matter how expensive they get."
Goldwein wants to adjust the inflation measure so instead of comparing the same basket month after month, analysts would make substitutions, just the way real shoppers do. He stresses that he's not talking about customers who reluctantly switch to an inferior product.
"It's not as if people are always going from steak down to chicken. Sometimes people are going from chicken to steak," he says.
The federal government already calculates this alternative measure of inflation. It's called "chained CPI." And over the past decade, it has typically shown prices rising a little more slowly than the regular Consumer Price Index — about a quarter to a third of a percent slower each year. That might not sound like much, but over time it adds up.
If the government switched to chained CPI for cost-of-living adjustments, Social Security payments and other benefits would grow more slowly. And tax revenues would go up, because parts of the tax code are also indexed to inflation.
Goldwein, who worked for the Simpson-Bowles commission, estimates that the switch would shave more than $200 billion off the deficit over the next decade. Because most of those savings would come in later years, it wouldn't be an immediate drag on the economy.
"Given that the economy is still weak, we don't want massive amounts of deficit reduction right now," Goldwein says. "That's the whole reason we're avoiding the 'fiscal cliff.' It's too much deficit reduction too fast. The chained CPI is the best of all worlds, because it gives you a credible way to reduce future deficits but with barely any effect in the short term."
But some seniors are up in arms over the idea.
Cristina Martin Firvida of AARP says if Social Security payments grew more slowly, the very elderly would suffer the most. She also complains that chained CPI doesn't reflect the actual cost of living for seniors.
"Obviously, more of their money goes to health care. Health care grows faster than inflation. And if folks want to have a conversation about accuracy, we would welcome adoption of a more accurate market basket. And one that really reflects the spending patterns of the retired and the disabled," Firvida says.
The government actually has another inflation measure that's specially tailored for seniors. Unlike chained CPI, it tends to show more inflation rather than less. That measure is based on a smaller sample, though, and it's not officially recognized.
Congressional Republicans call for switching to chained CPI in their deficit-cutting proposal. So far, President Obama has been noncommittal.
Goldwein says despite the controversy, chained CPI is one of the least painful deficit-cutting moves the government could make. If there is any big budget bargain, he says, the new inflation measure is likely to be part of it.