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  • A Step in the Right Direction: Obama’s Chained CPI Proposal

    Obama speaking about the FY 2014 budget

    MANDEL NGAN/AFP/Getty Images/Newscom

    Outside the President’s general, grow-the-government, increase-the-debt, tax-the-rich budget themes lies a commonsense proposal to use a more accurate measure of inflation when calculating government benefit growth rates and changes in income tax brackets.

    The purpose of inflation-based adjustments is to account for changes in prices over time. But current inflation measures stop a step short. They fail to account for changes in purchases that people make as a result of changes in prices.

    For example, if the price of bananas were to rise from $0.40/lb to $10/lb, all but a small subset of the population would stop buying bananas and instead buy more apples and oranges. Using the current measure of inflation, however, would assume that everyone keeps buying the same allocation of fruit when bananas rise to $10/lb as they did when they were $0.40/lb.

    Most price changes are not nearly this drastic, but consumers do respond to changes in prices, and they are not necessarily any better or worse off as a result of changing their buying patterns.

    Current inflation adjustments not only increase the size of beneficiaries’ payments over time (such as Social Security retirees’ checks), but also the purchasing power of those payments. The goal of inflation adjustments is to allow beneficiaries to purchase the same amount next year as they did this year, not more.

    A more accurate inflation adjustment would seek to maintain the same overall quantity and quality of a basket of goods and services while not specifying precisely what individual products and brands of products must be included in that basket. This is precisely what the chained consumer price index (CPI) attempts to track—a constant level of purchases that allows for small changes in items and brands based on consumers’ responses to changes in prices.

    While the President’s recommendation to use the chained CPI is a move in the right direction, his budget fails to fully implement the new measure. By exempting certain “vulnerable” populations, the President inherently discredits the merits of his own proposal. If the chained CPI is a more accurate inflation measure, it should be applied universally, not selectively.

    Democrats and Republicans alike should support a move to the chained CPI on pure policy grounds. Moving to a chained CPI is the right policy in tax reform, where Congress can offset the revenue it raises with pro-growth policies like lowering marginal tax rates. But is should not be used as a way to raise revenue.

    Posted in Economics [slideshow_deploy]

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