Monday, April 15, 2013

My take on the Chained CPI: A bad deal all around

I write that:

The Chain-Weighted Consumer Price Index (or chained CPI, for short), which President Obama included as part of his formal budget proposal, seems like a no-brainer for any White House–GOP grand bargain on the budget deficit. After all, the chained CPI is a better measure of inflation than the indices the federal government currently uses, and this simple technical fix would reduce entitlement spending and increase tax revenues by a combined $340 billion over ten years, providing something for both sides to like and dislike. Yet as pressing as federal deficits and debt are, the chained CPI is bad policy that both liberals and conservatives may come to regret.
Check it out, over at National Review.


JoeTheEconomist said...

"After all, the chained CPI is a better measure of inflation than the indices the federal government currently uses"

I want to make sure I understand your thought here.

Last year, I bought X healthcare insurance, the cost of which is growing rapidly. This year I switched to a high deductible so that I could keep the same premium.

Your article seems to suggest that there is no inflation in healthcare insurance because I switched to a higher deductible. Is that correct?

Andrew G. Biggs said...

Well, that's actually not a great example, since the CPI would measure the health services you consume, not the insurance (I think). The basic point is that consumers are constantly switching the basket of goods they purchase in response to changing prices, and it's not all of the 'steak gets more expensive so I buy dogfood' kind of thing.

JoeTheEconomist said...

The issue I have here is that Chain-CPI doesn't measure inflation more accurately. It measures at least in part the behavioral response to inflation. The example I gave is just the extreme view. Maybe there is a difference between buying power and cost of living. You are certainly losing buying power even if you adjust your costs for living.

Insurance isn't health care. It is the cost to manage risk. I spend a $20,000 to get insurance and I don't get any healthcare at all. In fact, the cost creates the high blood-pressure that induces me to buy healthcare for which I buy the insurance.

It is risk-management and a buyers-union to negotiates prices for me. And it should appear in CPI outside of healthcare.

WilliamLarsen said...

JoeTheEconomist has a good point. The chained CPO is not a more accurate measure of inflation, but a different measure of inflation.

Inflation is supply and demand. If there is less demand for a product, there are less sales and general the price drops. Less demand could be due to different products competing for sales or that the product itself is outdated (slide rule).

However, a more important point is that neither of these cpi calculations make any different in terms of Social Security OASI's ability to pay scheduled benefits.

COLA as defined by legislation has several factors that reduce or make COLA zero in any given year.

Recently the COLA paid for 2010 and 2011 was zero due to the cpi not being greater than any previous cpi year. There is another requirement for paying COLA and that is based on Trust Fund to Projected Expenses.

Congress wrote that when the ratio of Trust fund to Projected expenses reach 30% that for each 1% reduction in the ratio, the COLA if any calculated would be 10% less. When the ratio reaches 20%, COLA is zero.

Does it really make any difference if the chained cpi or the current cpi calculation is used?

SSA Trustees have repeatedly for 15 years sent statement so workers stating that at some point in the near future the trust fund would be exhausted. To me that means SSA is taking the trust fund to zero which means the ratio is zero which means that COLA is zero.

I think there are bigger fish to fry than worrying about COLA.

WilliamLarsen said...

The Chained CPI objective is to account for changes in spending: when meat goes up, people buy less meat and maybe lower price chicken.

Many think this is a bad idea for Social Security in the theory that the elderly spend more on healthcare that rises faster.

It is rather strange that people like the concept that when prices go up, spending shifts to other products, yet when it comes to the elderly "shifting" more of their capital to "healthcare" away from raising children, college, mortgage, etc, that it is unfair.

The fact is if we look at age 21 through 65 we find a series of evolutionary and predictable stages in life.

Young - you start out with nothing, borrow for furniture, kitchenware, vacuum cleaners, cars, etc.

Middle age young - now that you have been working you are less likely to buy "starting" infrastructure and are now looking at possibly raising a family. Shifting to raising kids.

Middle age old - now that your kids are nearing graduation, college costs may be a factor as well a maintenance on a home (18 years for roofs, ten years for paint, heating, A/C, etc. You capital now shifts once again to other products.

50-65 - kids are moving out of the house, house should be nearly paid off and expenses should be dropping steadily and again your capital is shifting to other products/services.

Retirement - Fixed income is a mystery to me. While working I was also on a fixed income with periodic raises that saw much removed as Social Security, Medicare, Federal, State as well as the lost of dependents, college and child tax credits so in many ways my income was reduced after taxes while Social Security increase by the CPI.

When we start tinkering with a formula and trying to match it a particular groups "specifications" we tend to alienate or shift the burden to others.

Social Security in 1940 did not have COLA and it was not enacted until the mid 70's. However between 1950 and 1974 benefits were periodically increased which resulted in far larger increases then the cpi would have.

Social Security has a financial shortfall of over $30 Trillion in present terms. Why are we tackling a leak similar to a dripping faucet when the hoover dam is about to burst?