Wednesday, April 10, 2013

Social security should be indexed to Chained CPI.

The difference between different inflation measures didn't seem too important to most people, until the President unveiled his budget which proposes to link Social Security (among other things) to something called "Chained CPI".  This seems like some arcane adjustment, but in fact it is very important.

Background:   We frequently refer to the change in CPI (consumer price index) as being the rate of inflation - but in reality it is merely one way of estimating the rate of inflation.   The CPI-U (U refers to urban consumers) measures the price level of a representative basket of goods.   The problem with the CPI-U is that it doesn't account for substitutions of one item for another.  For example, this week apples are expensive, but bananas are not, so a consumer may switch between the two.   If the price index is measuring the cost of living, then it makes sense to include these substitutions.  This is what the Chained CPI does.

The President's proposal is to link increases in Social Security benefits to this Chained CPI measure.   Because the Chained CPI doesn't increase quite as fast as the non-chained CPI which is currently being used, the net result is that Social Security benefits won't increase as rapidly.

In the short run, there won't be much of a difference, but in the long run the difference will be far more noticeable.  Not surprisingly, many advocates for seniors are complaining that this amounts to a reduction in benefits.  While technically correct, the fundamental question is what are the benefits that Social Security recipients are entitled to?

As The Economist explains, by indexing Social Security to the ordinary CPI, retirees have, in effect, been getting a real increase in their benefits (note that the word "real" means an increase above the rate of inflation).  Even if we were to link Social Security to an index that tracks a basket of expenditures that are more typical of retirees, the rate of increase would still be less.

Given that we're facing an ever increasing federal debt, this seems like a reasonable and fair way of tackling at least part of the problem.  It is also worth noting that by not dealing with this problem, the children and grandchildren of today's retirees will most certainly be paying more in taxes and getting less in benefits.