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Home Publications Blogs CEPR Blog Thoughts on the Chained CPI, Social Security, and the Budget

Thoughts on the Chained CPI, Social Security, and the Budget

Written by Dean Baker   
Monday, 17 December 2012 21:43

According to reliable sources, the Obama administration is seriously contemplating a deal under which the annual cost of living adjustment for Social Security benefits would be indexed to the chained consumer price index rather than the CPI for wage and clerical workers (CPI-W) to which it is now indexed. This will lead to a reduction in benefits of approximately 0.3 percentage points annually. This loss would be cumulative through time so that after 10 years the cut would be roughly 3 percent, after 20 years 6 percent, and after 30 years 9 percent. If a typical senior collects benefits for twenty years, then the average reduction in benefits will be roughly 3 percent.  

There are a few quick points worth addressing:

  1. The claim that the chained CPI provides a more accurate measure of the cost of living;
  2. Whether Social Security benefits are now and will in the future be sufficient to allow for a decent standard of living for retirees; and
  3. Whether this is a reasonable way to be dealing with concerns over the budget.

This are taken in turn below.

Is the Chained CPI More Accurate?

While many policy types and pundits have claimed that the chained CPI would provide a more accurate measure of the cost of living for seniors, they have no basis for this claim. The chained CPI is ostensibly more accurate for the population as whole because it picks up the effect of consumer substitution as people change from consuming goods that increase rapidly in price to goods with less rapid price increases.

While this is a reasonable way to construct a price index, it may not be reasonable to apply the consumption patterns and the substitution patterns among the population as a whole to the elderly. The Bureau of Labor Statistics (BLS) has constructed an experimental elderly index (CPI-E) which reflects the consumption patterns of people over age 62. This index has shown a rate of inflation that averages 0.2-0.3 percentage points higher than the CPI-W.

The main reason for the higher rate of inflation is that the elderly devote a larger share of their income to health care, which has generally risen more rapidly in price than other items. It is also likely that the elderly are less able to substitute between goods, both due to the nature of the items they consume and their limited mobility, so the substitutions assumed in the chained CPI might be especially inappropriate for the elderly population.

While the CPI-E is just an experimental index, if the concern is really accuracy, then the logical route to go would be for the BLS to construct a full elderly CPI. While this would involve some expense, we will be indexing more than $10 trillion in Social Security benefits over the next decade. It makes sense to try to get the indexation formula right.

Are Social Security Benefits Adequate?

While some people have tried to foster a myth of the elderly as a high living population, the facts don’t fit this story. The median income of people over age 65 is less than $20,000 a year. Nearly 70 percent of the elderly rely on Social Security benefits for more than half of their income and nearly 40 percent rely on Social Security for more than 90 percent of their income. These benefits average less than $15,000 a year.

The reason that seniors are so dependent on Social Security is that the other pillars of the retirement stool, employer pensions and individual savings, have largely collapsed. Defined benefit pensions are rapidly disappearing. Defined contribution plans, like 401(k)s have also proved grossly inadequate. Only around half of the work force even has a defined contribution plan available to them at their workplace. In a period of stagnant wages and limited employer contributions, workers have generally been unable to accumulate much wealth in these plans. According to the Retirement Research Center at Boston College, the median value of 401(K) and other defined contribution plans for those near retirement who have a plan is $120,000, enough to get an annuity paying $575 per month.  

For most workers the vast majority of their wealth was in their homes. The collapse of the housing bubble destroyed much of this equity. Counting all forms of wealth, including equity in a home, the median household approaching retirement had just $170,000 in wealth in 2011.

The proposed cut in the annual cost of living adjustment will be a substantial hit to a population that for the most part is ill-prepared to see a cut in its income. The effect of this cut on the income of the typical beneficiary will be larger, measured as a share of income, than the return to Clinton era tax rates on the richest 2 percent will be to the people affected. It is also worth noting that this cut to benefits will affect current retirees, not just people who will be collecting benefits 10 or 15 years in the future, who might have some opportunity to adjust to a cut.

Is the Chained CPI a Reasonable Way to Deal with the Budget

It is important to remember that under the law Social Security is supposed to be treated as a separate program that is financed by its own stream of designated revenue. This means that it cannot contribute to the budget deficit under the law, because it is only allowed to spend money from the Social Security trust fund.

This is not just a rhetorical point. There is no commitment to finance Social Security out of general revenue. The projections from the Social Security trustees show the program first facing a shortfall in 2033 after which point it will only be able to pay a bit more than 75 percent of scheduled benefits. While this date is still fairly far in the future, at some point it will likely be necessary to address a shortfall.

It is reasonable to expect that the changes needed to keep the program fully funded will involve some mix of revenue increases and benefit cuts. However if the chained CPI is adopted as part of a budget deal unconnected to any larger plan for Social Security then it effectively means that there will have been a substantial cut to Social Security benefits without any quid pro quo in terms of increased revenue. This hardly seems like a good negotiating move from the standpoint of those looking to preserve and strengthen the program.

There is also the question of whether the Social Security trustees will even “score” this cut accurately. In the 1990s there were changes to the CPI that had the effect of reducing the measured rate of inflation by at least 0.5 percentage points annually (Economic Report of the President 1998 Box 2-6). This would have implied a reduction in the annual cost of living adjustment by this amount and a corresponding improvement in the Social Security trust fund’s prospects. However, there is no evidence of this improvement in the program’s finances during this period. In fact the projected rate of real wage growth (the difference between the nominal rate of wage growth and the measured CPI) was 1.0 percent in 1995, before the changes to the CPI. The projected long-run rate of real wage growth had actually been lowered to 0.9 percent in the 1998 Trustees Report (Table II.D.1) which was issued after all the reductions in the CPI had been put in place.

It is important to remember that the trustees projections come from the trustees, not the professional staff of the Social Security Administration. Four of the six trustees are political appointees of the president. It is certainly possible that the cuts associated with the adoption of the CPI will not be factored into the trustees projections just as the even larger cuts associated with the changes in the CPI in the 1990s were not factored into the trustees projections.

Finally, it is worth commenting on the idea of tampering with statistical measures to achieve budgetary goals. The United States has been fortunate in having independent statistical agencies that have fiercely resisted efforts to manipulate data for political ends. In fact, in the 1990s there was considerable pressure placed on the Bureau of Labor Statistics to make adjustments to the CPI which would reduce Social Security and other indexed benefits. Katherine Abraham, the then head of the agency was steadfast in refusing to make any changes to the index that were not justified by BLS research.

The current effort has the spirit of using statistics for political ends, for example by refusing to have BLS produce a full elderly CPI so we would actually know the inflation rate experienced by the elderly. There also has been some discussion of leaving some programs, such as Supplemental Security Income, tied to the current CPI so as not to hurt a seriously disadvantaged population.

Congress can decide the benefit formula for these programs as it chooses. The honest way to cut benefits is for Congress to explicitly vote to cut benefits, not to try to hide a cut behind a statistical manipulation. This is the sort of behavior that encourages public contempt for politicians and the political process.  

Comments (18)Add Comment
written by Brett, December 17, 2012 9:10
This is cutting for the sake of cutting.

I think your point that Social Security by law can't contribute to the budget deficit is the biggest point, even more than the others. This is just a giant ruse on the American people. We have a budget problem (which we don't really, but that's another argument). So the fix? Cut the safety -- specifically the part that doesn't contribute to that deficit.

What a scam. This is why rich people shouldn't be governing us. They cut programs that they don't need and don't particularly care about. Obama has multiple top selling books, he's a millionaire many times over, and he stands to make hundreds of millions giving speeches after he's done with his second term, a la Bill Clinton. So protecting money that is really important to people struggling to get by isn't his biggest priority.
The story is in the fraud
written by David , December 17, 2012 10:15
I agree that the real story here is the fraud of bringing SS into this discussion, a fraud to which Obama will be a party.
written by Jonah, December 18, 2012 6:35
Obama is so disappointing. I only voted for him again this time because the alternative was pure evil.
Statistics Professor
written by Dave Kingsley, December 18, 2012 7:30
I agree with most everything you have said Dean. However, I do not agree that there is any scientific justification for adjusting the CPI down due to substituion bias. I have yet to find any valid scientific study which has established this. I would say the same thing about the hedonic adjustment and a switch to from an arithmetic mean (Laspereyes Index) to a geometric mean (Tornvquist). This move on Obama's part is nothing less than outrageous.
Yes, fix SS
written by Dr Professor , December 18, 2012 9:23
Social security is now paying out more than it takes in, so it certainly is in need of a fix. The trust fund is essentially meaningless since this deficit results in either more debt or higher taxes regardless.

The most accurate measure for the CPI should be used, ignoring political considerations.
written by Jim Naureckas, December 18, 2012 9:57
One of the nastiest features of the chained CPI brainstorm is that the oldest elderly will pay the most--if you live into your nineties, you could easily see your monthly check cut by 10 percent or more.
written by ltr, December 18, 2012 10:00
I am appalled at the President's proposal. This President cares nothing for us.
Please write more about inflation calculations
written by janinsanfran, December 18, 2012 5:20
I have never met anyone who felt that their experience of prices bore any relation to what the media and economists told us about inflation. These calculations always seem divorced from experience. Now I know inflation figures exclude gas and some other things because they are thought to be too volatile to measure usefully -- how am I supposed to think that inflation measurements are meaningful when they exclude the drivers of our personal economies? I'm being serious here, not just snarking.
written by Anna Lee, December 18, 2012 6:43
A budget substitution is a one time event. The chained CPI is cumulative. How can such an inflation index possibly work to do other than require the impossible life style changes over 20 to 30 years? Once someone runs out of cheaper substitutions doesn't this just become a scam of bitter proportions? (Even if the first two or three years forces people to give up protein in their diet.)
written by JSeydl, December 19, 2012 8:34
Nice write up, Dean. Very informative.
Ruler of Omicron Persei 7
written by falk burger, December 19, 2012 9:41
I've been ranting about the travesty of "chained CPI" for years. This is the fallacy: If folks switch from steaks to burgers to make ends meet, that is not inflation, but the market's reaction to it. What do burger eaters switch to? Beans? And bean eaters? Dirt? From there, it's turtles all the way down, if you get my drift. The actual effect on the economy is the opposite: as the quality of food declines, people switch to quality and organics, and inflation actually increases! Moreover, as food budgets increase, this leaves less disposable income to feed the economy, and brittleness ensues, contributing to boom-bust vulnerability.
Thank you
written by John Donnelly, December 19, 2012 2:00
This is a very helpful analysis of the Chained CPI issue. I also appreciate the facts on the Social Security issue in general.
Dedicated revenues; separate part of the budget
written by Don Levit, December 19, 2012 2:24
SS does not contribute to the deficit?
The surplus principal has been lent to the Treasury over the years. The interest credited to the fund is done with additional debt. The trust fund balance is called intragovernmental debt, not intragovernmental equity.
From a cash perspective, the shortfall since 2010 has been redeemed with general revenues, an immediate expense, and adding to the deficit.
At trust fund exhaustion, the same financial dynamics will occur.
The trust is not exhausted in 20 years. It is exhausted today.
Don Levit
We were lied to by Obama, Biden and Pelosi
written by bmull, December 19, 2012 6:56
I’m horrified by Obama's chained CPI plan. The present debate is not about fixing Social Security. It’s about a short-term budget deal. None of the new tax revenues (which as you mentioned are highly regressive) are earmarked for Social Security. If you look at Reagan’s 1983 deal, as bad as it was, at least it was a comprehensive plan which significantly improved Social Security’s finances. It did not muddle the crucial distinction between Social Security and the general budget mess. The precedent of cutting entitlements primarily to get the federal government off the hook for interest payments to the trust fund is a horrible one for Democrats to have set.

The federal government used money from the trust fund to pay for tax cuts for the rich, two unnecessary wars and a fatcat-induced financial crisis. Now, they’re making the trust fund cut its outlays so it won’t need that money back on Obama’s watch. People making up to $400,000 meanwhile get to keep their Bush tax cuts, their dividend cuts, their estate tax cuts, and a number of other policy changes that would otherwise cost the rich disproportionately. Does that sound fair or does it sound like a scam? I have seen first-hand how important it is for seniors to be financially secure, so they can participate in the children’s and grandchildren’s lives. It’s very sad when they have to live far away in low-income areas and can’t afford even to buy Christmas gifts. FDR must be rolling in his grave.
written by Shirley Royer, December 20, 2012 10:22
This is outrageous. Don't touch medicare and don't touch medicaid but for God's sake don't change or touch
Social Security. It has nothing to do with the deficit. The Republicans want their hands on it to put it in the stock market so all the elderly people will starve.
1983 Reagan deal - what about saving the surplus for SS?
written by Don Levit, December 20, 2012 10:31
bmull wrote:
The federal government used money from the trust fund to pay for tax cuts for the rich, two unnecessary wars, and a fat-cat-induced financial crisis.
Actually, the Treasury spent the surplus on government expenses, lowering the deficits. Apparently, these expenses were not directed specifically at a few targets.
The Reagan deal you spoke of, do you think it included Treasury borrowing the surplus? If that had not occurred the trust fund balance would be $2.7 trillion of intragovernmental equity, not intragovernmental debt.
Don Levit
written by Mary Bess, December 21, 2012 2:03
If SS benefits are only to be paid out of its own revenue stream, why can't beneficiaries (and future beneficiaries?) sue the federal government (or the SS Trustees?) for tapping into that stream for other purposes or allowing that to happen?

Thank you for all the informative articles you've written about SS and Medicare.
Sue the federal government for using the trust fund surplus?
written by Don Levit, December 21, 2012 9:43
Mary Bess:
Good question. The primary reason is that the SS trust fund is funded with taxes. It has been ruled several times by the Supreme Ct. that the taxes cannot be specifically directed to certain beneficiaries. Rather, taxes are for the general welfare.
All the FICA taxes, from a cash flow standpoint, flow into the Treasury's general fund, where they become indistinguishable from other monies.
Don Levit

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