Obama’s Chained CPI Controversy Explained

by Darwin on April 15, 2013

In last week’s budget announcement, the Obama administration included a provision which has liberals howling.  Without delving into mudslinging about political motivations, feigned outrage and the slanted media coverage this proposal has generated, let alone the irony that this measly cut was mixed in with $1 Trillion in tax increases during the same 10 year period, let’s get right into the economics.  First off, what is chained CPI and why does it matter?

Chained CPI Explained

Obama’s 2014 budget includes a provision to switch to a “chained CPI” formula for calculating annual inflationary increases.  While the CPI deflator is utilized for all sorts of calculators, the most prominent one that has people talking is how it affects the inflationary increase that Social Security recipients benefit from.  CPI is the consumer price index which is a bucket of routine expenses incurred by Americans (see why the CPI is a joke and what the real inflation index is).  Since this has been the prevailing method of calculating how large an increase a typical retiree receives each year, any change to that formula would be met with resistance.  Well, it’s well-known that the current CPI overstates actual inflation because of a major flaw in human behavior.  When the price of something increases, people don’t necessarily pay it.  Nor do they always stop purchasing a product at a given price point.  No, what people do, is they substitute.  The cost of beef spikes?  Well, buy some pork or chicken.  The price of oranges spikes? Buy grapefruit.  You get the picture.  This is what people do in real life, which the routine CPI does not account for.  The CPI holds rankings of various goods and services steady rather than reflecting this reality.  What the chained CPI does is adjust for the fact that people substitute.

Financial Impact of Chained CPI

So, you’re probably wondering if this is going to throw granny off the cliff.  Of course not, but more importantly, let’s talk about what’s really going on here.  Rather than claiming this is a “tax on seniors” and other political pandering, let’s start at the beginning.  All inflationary indices are flawed in some way and never represent everyone (per my prior link), but knowing we need to use something,  1) We know that CPI overstates the actual inflationary pressures in that bucket because it ignores human behavior.  2) This means that retirees have consistently, and would continue to be, overpaid because the government is using a formula that overstates the inflationary increase they are entitled to.  So, 3) Chained CPI corrects this known flaw.  4) Incidentally, this helps stem the hemorrhaging of finances in our Social Security system albeit barely scratching the surface. But for once – once, it shifts the spending curve back instead of forward like virtually every other move the past few administrations have made.  The White House estimate for the savings is $230 Billion over 10 years.  To simplify (yes, ignoring some demographic shifts and the present value of money), let’s call it $23 Billion/year.  When we’re running deficits of $1 Trillion per year, this is equivalent to less than 2% of our current overspending.  Not 2% of our budget, but just the amount above and beyond our budget that we spend.  And yes, I know, Social Security does not directly pull from existing revenues and cause deficits, but we know the system is insolvent and as a whole, cash in must equal cash out over long periods of time or it’s a deficit, so let’s just call it what it is.

Think Like an Economist, not an Emotionalist

The same arguments that teachers should be paid an infinite amount of money because what they do is so important could be used here.  Poor seniors are going to go off the cliff if they don’t get their CPI versus chained CPI.  The reality is the country needs to get real about spending and government programs in particular. Getting emotional and lacking objectivity about finances is what gets people (and governments) in trouble.  Here are the facts:

  • Most Social Security recipients are seeing more much transferred to them than they put into the system, whereas future generations will see a substantial decline, likely even negative returns or complete confiscation.  This is generational theft.  It’s fair and reasonable to try to preserve some semblance of benefit to future generations, who of course, are paying into the system as well – often at a much higher rate than the current generation of retirees.
  • The monthly difference between CPI and Chained CPI payments is on the order of a few bucks a month for a lower income senior.  Granted, they will notice a difference and I’m not minimizing that.  But, they’ve been receiving larger increases than they should have every year past due to the explanations above.  Chained CPI more fairly and accurately assess their future increases.
  • Many Social Security recipients don’t need the money.  They are entitled to it, sure.  They paid into the “system” after all.  But if they’re getting a check for $2200 a month next year instead of $2225, when you pile on their pensions, savings and other government bennies, they’ll be OK.  Really.

What are Your Thoughts on Including Chained CPI in Social Security Increases?


{ 1 comment… read it below or add one }

Jenny @ Frugal Guru Guide April 16, 2013 at 8:22 am

Social Security is unsustainable. Something must be done–something far more drastic than using chained CPI. I’ve already become resigned to the fact that SS will likely be defunct when I am a senior. I’m just hoping now that it doesn’t deep-six the entire economy first. I can survive in old age without SS. I can’t survive if all my savings are worthless.


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