Committee for a Responsible Federal Budget

Martin Neil Baily and Glenn Hubbard Make A Case for Chained CPI

May 10, 2013 | Social Security

Two former Chairman of the Council of Economic Advisors, Martin Neil Baily of the Clinton Administration and Glenn Hubbard of the Bush Administration, made a bipartisan case for the chained CPI in yesterday's The Hill. The two economists emphasize the technical case for the chained CPI, and push back against the CPI-E, which some critics have proposed to use instead.

Over the last few days, politically driven critics have called on the president to abandon his support for changing the way the government indexes provisions in the budget to inflation by switching to “chained CPI.” Looking beyond politics, we’re here to say that these critics’ arguments are wrong on their merits.

As economists from opposite ends of the political spectrum, we would strongly urge the president and leaders in Congress to continue to support moving to chained CPI, which represents the most accurate available measure of inflation and cost-of-living increases. Switching to this more accurate measure of inflation represents the right technical, fiscal and retirement policy — and policymakers should not delay any further in making this improvement.

From a technical sense, the current CPI — or consumer price index — that is used to index many parts of the budget and tax code is widely understood to overstate inflation. This is because it fails to account for so-called “substitution bias,” in which consumers reallocate their purchases depending on the relative prices of similar goods. For example, if the price of apples goes up, consumers will buy more oranges. However, this behavior is not accounted for in standard CPI measurements.

The Bureau of Labor Statistics, which calculates the CPI, is very aware of this shortcoming, which is why it has developed and refined the chained CPI for more than a decade. The nonpartisan Congressional Budget Office states that the chained CPI “provides an unbiased estimate of changes in the cost of living from one month to the next.”

Some argue that using the chained CPI to index Social Security benefits is inappropriate because it does not reflect inflation for retirees, which critics suggest is higher than it is for working-age adults because of the elderly’s higher rate of spending on healthcare. However, the CBO has said that based on the available research, it is unclear whether the cost of living actually grows at a faster rate for the elderly than for younger people, and that the CPI-E  —“E” for “experimental” — which was intended to provide a more accurate measure of inflation for seniors, has several methodological flaws that overstate inflation, including underestimating the rate of improvement in healthcare.

The benefit and tax changes may be a difficut side effect of switching to the chained CPI for both parties, but the advantage of using a more accurate measure of inflation should more than justify the switch. Given our fiscal outlook, similar changes will have to be made regardless, and none provide the same benefits as the chained CPI.

The federal government should not knowingly continue to measure inflation inaccurately, especially given the costs to the budget and to the Social Security program. Changes that cut Social Security benefits are a tough sell for Democrats, and changes that increase revenue are a tough sell for Republicans. But if they cannot even agree to a technical correction to those areas of the budget, how will they be able to make the hard choices to control our debt and reform our government over the long term?

Click here to read the full op-ed.