The Wonky Reform That Could Save Us $300 Billion

By Derek Thompson

Ready to hear about a cool but wonky idea that could save us about half as much as letting the Bush tax cuts expire on the rich? Adam Rosenberg and Marc Goldwein have a new clear-eyed paper that calls for changing -- or rather, chaining -- the way the government measures inflation.

Think about Social Security. It's a check-mailing program, basically. The first check is determined by your wages. Then next year's checks get a bump to keep up with cost of living. That bump is determined by the consumer price index.

We can't measure the price of every single item, so instead CPI focuses on a finite "basket of goods." The problem with this approach, Rosenberg and Goldwein argue, is that we don't account for when consumers start buying outside the basket.

Here's a good example from the paper: If I'm buying green apples, and the price of green apples increases, I'll buy more red apples. This apples-to-apples shift is captured in current inflation indices. But what if I stop buying apples and I switch to oranges? That kind of apples-to-oranges shift isn't captured in CPI, because oranges aren't in the basket of goods.

For that reason, the authors suggest switching to a "chained" inflation measure, so-called because it provides a broader estimate of changes in cost-of-living that create a month-to-month chain.

Moving to the chained CPI would address this bias by using a superlative index which updates expenditure weights and formulas in order to address consumer response to substitution between categories. As the Congressional Budget Office (CBO) explains, the chained CPI "attempts to fully account for the effects of economic substitution on changes in the cost of living... [It] provides an unbiased estimate of changes in the cost of living from one month to the next by using market baskets from both months, thus 'chaining' the two months together."

Moving to a "chained CPI" would save $300 billion over the next decade, with about half of the non-interest savings coming from smaller Social Security benefits. I'm not excited about trimming Social Security benefits in the next few years, since today's seniors are struggling with devastated 401(k)s and sorry looking pensions. But this idea should certainly be a part of the broader discussion about how to fix the budget in the years to come. Moreover, it's a good example of outside-the-box thinking that moves the discussion toward the important question: "How should we use this moment of budget reform to fine-tune the way government measures and delivers benefits?"

This article available online at:

http://www.theatlantic.com/business/archive/2011/05/the-wonky-reform-that-could-save-us-300-billion/238772/