'Chained CPI,' and what it means to you

It could mean lower cost of living adjustments in Social Security benefits

When President Obama proposed a new budget, he managed to upset just about everyone, including members of his own party.

Republicans attacked the proposal for its increase in spending and taxes. Liberal Democrats took issue with Obama's willingness to change the way Social Security cost-of-living increases are determined, switching to something called, in Washington-speak, “chained CPI.”

Currently, the U.S. government uses the Consumer Price Index (CPI) as the main measurement of inflation, determining how Cost of Living Adjustments (COLA) are applied to federal programs like Social Security. People who receive Social Security benefits usually get an annual increase in their benefits, based on how much the price of goods and services in the economy, measured by the CPI, went up in the previous year.

Overstating inflation?

But experts who have studied the CPI believe it overstates inflation, at least in the way that it affects most consumers. In 2002 the Bureau of Labor Statistics, part of the U.S. Labor Department, created “chained CPI” to address this concern.

In short, chained CPI is a more flexible, and some say more realistic way to look at inflation. It assumes that if the price of one consumer product goes up significantly, consumers will not continue their same purchase patterns. Instead, they will buy less of it, or respond but purchasing a different product that costs less.

When you add it all up, there is only a slight difference between the government's CPI and its chained CPI. In most cases, the chained CPI is only one-quarter of one percent less than the CPI.

Big argument

But this small difference in the way COLAs are determined is sparking a big political argument. Jim Centner, Director of the Steelworkers Organization of Active Retirees, says the President's proposal is disappointing.

“Cuts to Social Security cost-of-living adjustments (COLAs) and to Medicare programs places the burden of our nation's debt unfairly on the back of seniors,” he said. “The proposed chained CPI formula to determine Social Security COLA benefits will mean an immediate, and long-lasting, benefit cut for millions of Social Security beneficiaries, including seniors, veterans, people with disabilities and others.”

David Cox, President of the American Federation of Government Employees Union, went farther, calling the proposal shameful.

"Instead of holding to its promise to protect the middle class and the working poor, the Administration seems determined to contribute to a worsening of living standards for federal workers, disabled veterans, and the elderly," he said.

AARP, which lobbies for the interests of seniors in Washington, didn't like it either.

"AARP is deeply dismayed that President Obama would propose cutting the benefits of current and future Social Security recipients, including children, widows, veterans and people with disabilities, to reduce the deficit,” said AARP Executive Vice President Nancy LeaMond. “Social Security is a self-financed program that doesn't contribute to the deficit, so it shouldn't be cut to reduce it.”

Multiplying effect

The change to a chained CPI formula would not reduce the amount of a Social Security recipient's benefit. But it would reduce, very slightly, the amount of the increase each year. Over time, advocates say, the compounding effect of that slight decrease, multiplied over millions of recipients, would produce significant deficit reduction.

Opponents, on the other hand, point out that a reduction in benefits, while small in one year, adds up over time, so that the benefit recipient is not keeping up with the cost of living. Groups like AARP see a switch to chained CPI as a move to weaken retirement security programs.

One of the few groups to publicly support the President's budget is The Campaign to Fix The Debt, a bi-partisan group headed by Republican Judd Gregg, a former Senator, and Democrat Ed Rendell, a former governor.

“While we believe some of these proposals should go further to address the debt and ensure important programs remain solvent – especially on shoring up Social Security's finances – we applaud the President for including measures, such as further means-testing of Medicare premiums and reduction of agricultural subsidies, that can be helpful in building bipartisan support,” the group said in a statement.

An economist's take

Economist Joel Naroff, of Naroff Economic Advisors, in Holland, Pa., agrees that the switch to chained CPI would reduce the deficit, he argues that it should be done in such a way as to not hurt the most vulnerable.

“Just using chained CPI puts the greatest burden on those whose only income comes from Social Security,” Naroff said. Those who have other sources of retirement funds would see a smaller percentage decline in their income. Those who are saying using the chained CPI is unfair should instead argue that reductions should be based on income. That is, if you don't want low-income people to shoulder the greatest burden, you then have to be willing to reduce those who have more income: i.e., means test Social Security in some way.”

And that gets to the crux which would likely be an even more explosive issue.

“Does it really make sense for the government to provide retirement funds to high wealth/high income retirees?” Naroff asks. “That is what the debate should be all about.”

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