The Chained CPI and the Advantages of Going Big

CBPP released a paper last week re-affirming their support for switching to the chained CPI for calculation inflation adjustments for benefit programs and the tax code.

They said that the index better measures inflation because it accounts for upper-level substitution bias. While the traditional CPIs account for consumers substituting one good for another in the same category when the price of the first good rises (say, switching from Granny Smith to Red Delicious apples), it does not account for substituting between goods from different categories (for example, apples and oranges). The chained CPI accounts for the latter case--upper-level substitution bias--and thus better accounts for the purchasing habits of consumers. You can read more on the technical case for switching to the chained CPI in the Moment of Truth Project paper "Measuring Up."

Since 1996 — partly in response to the recommendations of the Advisory Commission to Study the Consumer Price Index— the Bureau of Labor Statistics (BLS) has made numerous improvements to the official CPI that have caused it to rise more slowly than it otherwise would have. In addition, BLS began publishing an alternative, "chained" CPI to address the commission's concerns about what is called "upper-level substitution bias. That change in methodology, however, did not apply to the official CPI, which continues to suffer from upper-level substitution bias.

CBPP also rejected using the Experimental Consumer Price Index for the Elderly (CPI-E), which weights health care and housing more, as an alternative measure for elderly benefit programs. They noted that since the CPI-E is usually higher than the CPI-W, using it for cost-of-living adjustments (COLAs) would worsen Social Security's future financing problems (although the CPI-E has been lower on occasion, including for this year's COLA). In addition, they said that the CPI-E is an incomplete measure at this point, and that to seriously consider using the index, the Bureau of Labor Statistics (which calculates price indices) should first expand on the index and develop a chained version to make it more methodologically robust. Still, they felt that using the index would not be a move in the right direction.

Average Cost-of-Living Adjustment With Different Indices
  CPI-W Chained CPI CPI-E
Last 20 Years 2.6% N/A 2.7%
Last 10 Years 2.5% 2.2% 2.5%
Last 5 Years 2.3% 2.0% 2.1%
January 2012 COLA 3.6% 3.4% 2.9%

However, since the chained CPI has widespread effects on benefits, CBPP worried about the effects of the switch on Supplemental Security Income beneficiaries, older seniors, and seniors with unusually high medical expenses. In all of these cases, they had ways of mitigating the effects for these three populations.

Unintentionally, these distributional concerns show one major advantage of a comprehensive fiscal plan: when you "Go Big", you have room to address concerns about individual policies through changes elsewhere in the federal government. Nowhere is this more apparent than with the chained CPI, a policy that has such wide-reaching effects. A comprehensive plan allows for lawmakers to consider the overall distributional effect of the entire package, rather than the effect of individual policies. This would take away the need for one-off exemptions or other carveouts that may undermine a policy or make it more complex.

It is notable that with regards to the last two populations that CBPP mentions, comprehensive fiscal plans have enacted changes that would mitigate the chained CPI's effects on them. Both the Fiscal Commission and Domenici-Rivlin plans would bump up benefits for Social Security beneficiaries from ages 80-85, and they would introduce a catastrophic cap on out-of-pocket Medicare expenses. In a nickel-and-dime plan, these changes likely would not be considered because they would be netting against a relatively small amount of savings and would likely be delving into areas that the plan would not touch otherwise. The chained CPI's roughly $200 billion in savings might not be worth it to lawmakers if it would involve enacting other policies to mitigate, for example, distributional concerns.

Being able to address concerns with individual policies is one big reason why we believe that trying for a comprehensive fiscal plan can actually increase the chances of succeeding in getting our debt on a sustainable path.