What New Inflation Formula Would Mean for Social Security Recipients
Mark Miller

"Chain, chain, chain, chain of fools." -- Aretha Franklin

Aretha was singing about a cruel lover. But her complaint applies equally well to another kind of foolish chain that's become a household word during this summer of federal budget battles: the "chained CPI."

That's shorthand for a policy idea kicking around Washington that would change the way inflation is measured for a variety of federal benefits and tax schedules.

Seniors have been hearing about the chained CPI lately in the context of Social Security--which is one of the few retirement benefits that comes with built-in protection against inflation.

Social Security has had an automatic cost-of-living adjustment (COLA) since 1975; seniors were paid a COLA every year from that point up until 2008, but since then -- nada.

Social Security's COLA currently is determined using a particular measure of the Consumer Price Index, called the CPI-W. Uncle Sam's stinginess resulted from a quirky spike in that index in the third quarter of 2008. Just before the economy crashed, the CPI-W spiked temporarily due to a big increase in energy prices. The result was a whopping 5.8 percent COLA for 2009. Social Security payments can't rise until the CPI-W exceeds the 2008 level -- and they can't fall under federal law -- so benefits were held level in 2010 and 2011.

A 1.1 percent COLA is forecast for 2012 by the Congressional Budget Office (CBO).

But in the meanwhile, the debate in Washington about debt ceilings and budget deficits has brought COLAs front and center.

Several of the key federal deficit reduction plans that have been advanced recommend replacing the CPI-W with a chained CPI. A chained index reflects changes that consumers make in their purchasing across dissimilar items in response to price changes; the theory is that a spike in gasoline prices will prompt consumers to spend less on fuel, perhaps more on food. (Or, as a reader of an earlier story I wrote on this subject quipped in an online comment: "Sure, when the price of steak goes up, people switch to chicken. And when the price of chicken goes up, old folks will switch to cat food.")

The chained CPI could be applied to federal benefit programs and to the income tax code -- although it stands to generate far more benefit cuts than revenue gains.

On the benefit side, a chained CPI would impact Social Security, civilian and military pensions and veterans' benefits and Supplemental Security Income. On the revenue side, a chained CPI might be applied to inflation adjustments for tax brackets in the personal income tax code, effectively serving as a stealth tax hike by reducing tax bracket adjustments and subjecting more of individuals' earnings to higher tax rates over time.

According to the CBO, benefit adjustments could yield $217 billion over 10 years, with 52 percent of that -- $112 billion -- coming from reduced Social Security COLAs; income tax bracket creep would generate $72 billion.

Here's what makes the chained CPI especially controversial insofar as Social Security is concerned. Whenever Social Security has undergone reforms in the past, the changes almost always have been scheduled far down the road and implemented gradually over many years, so as not to impact current beneficiaries already counting on a specific benefit. But shifting to a chained CPI would affect today's seniors.

The chief actuary of the Social Security Administration estimates that the chained CPI will rise about 0.3 percentage points less per year than the CPI-W. With compounding, that translates to a monthly benefit cut of 8.4 percent for a retiree at age 92 (calculated from age 62, the first year of benefit eligibility), according to the National Academy of Social Insurance (NASI).

That takes us in exactly the wrong direction on COLA policy. If anything, the current CPI-W measure understates the living costs experienced by the elderly -- especially healthcare costs. Healthcare inflation has far outpaced general inflation for several decades.

Since 1988, the U.S. Bureau of Labor Statistics (BLS) has maintained an experimental index, the CPI-E, which aims to reflect the spending patterns of people over age 62. Used instead of the CPI-W, it would translate into monthly benefits about six percent higher for a retiree at age 92, NASI estimates.

"Since most of the deficit reduction (that would result from using the chained CPI) comes from cutting benefits for elderly and disabled Americans, it does point one back to the question of whether the chained CPI is more accurate for elderly and disabled Americans," says Virginia Reno, NASI's vice president for income security. "Evidence suggests it is less accurate than a CPI for the elderly, because it fails to reflect the significantly larger role of out-of-pocket health spending by seniors and disability beneficiaries.

Proponents of a chained CPI usually describe it as a technical correction to make COLAs more accurate -- and a geeky topic only an economist could love. But it actually will have major implications out in the real world. So, no matter where this summer's fiscal debate goes in Washington, expect discussion of this rather foolish chain to stay hot.

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