It's Time to Measure Inflation Correctly

Today, the Moment of Truth project released a paper outlining the case for indexing federal programs to a more accurate measure of inflation, the chained CPI. Currently, many parts of the federal government -- including parts the tax code, Social Security, and many other programs -- are indexed for changes in either the CPI-U or CPI-W -- even though most economists believe these measures actually overstate inflation.

The paper describes the principal flaw of these measures in what is known as upper-level substitution bias. Because consumers often buy less of a product when it becomes more expensive and more of another as a substitute, consumers do not face the full brunt of the price changes that are recorded in the current CPIs. The chained CPI would better account for the ability of consumers to substitute goods between categories of goods, such as between apples and oranges. Making this technical fix would save roughly $300 billion over ten years (including interest) from all areas of the budget.

Budgetary Savings for Chained CPI by Category (billions)
  2012-2016 2012-2021
Social Security $27 $112
Other COLAs $8 $33
Other Spending* $3 $23
Tax Code $21 $87
Subtotal $60 $255
Interest $4 $44
Total $64 $299

*Excludes impact on Medicaid and health subsidies.

If lawmakers can't agree to a technical fix like switching to the chained CPI, there's little hope that they can agree to larger changes to our health care programs, tax system, Social Security, and military before markets force those changes on us. As the authors state in the paper:

"Addressing our fiscal challenges will require many tough choices and policy changes - but switching to the chained CPI represents neither. Such a change offers policymakers the rare opportunity to achieve significant savings spread across the entire budget by making a technical improvement to existing policies. As such, across-the-board adoption of the chained CPI should be at the top of the list for any deficit reduction plan or down payment"

Click here to read the full paper.