Chained CPI: The Sneaky, Complicated Idea That Could End the Fiscal Cliff Showdown—Explained

By Derek Thompson

What if I told you we could raise taxes, cut entitlement spending, and break the cliff stalemate for good, by changing one obscure policy? Ladies and gentlemen: Meet chained CPI.

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Reuters

If you're growing weary of the fiscal cliff, I do not blame you. Budget deals can be powerfully wearying stuff. But they are rarely as complicated as they seem from a distance.

Take, for example, the new proposal that some Republicans and Democrats think might end this terrible cliff showdown for good. It would involve a simple change to the way we measure cost-of-living. The proposal is called chained consumer price index -- or chained CPI.

Please don't run away. Yes, this sounds like an awfully fusty and complicated idea. That's somewhat the point, as Matt Yglesias mischievously points out, since fusty and complicated ideas are the least likely to raise the ire of voters who don't understand them. But chained CPI, in addition to being key to a budget deal, is also simple to understand.

LESS SPENDING, MORE REVENUE

Each year, wages and prices tend to go up. You know that already. But by how much? Washington needs to know. Social Security checks are supposed to grow each year to keep up with the cost of living, and tax brackets are supposed to go up each year to avoid a stealth tax increase on households.

Today, Washington tracks cost-of-living changes with various inflation measures that calculate the price of a "basket of goods." That's good for keeping track of a finite set of prices. But what if people start buying stuff outside that small basket? A classic example: If the price of romaine lettuce skyrockets, today's inflation measure assumes your salads get much more expensive, and your cost-of-living would go up. In the real world, though, maybe we'd just buy more iceberg lettuce. Maybe we'd stop eating salad, altogether.

The simple idea is that Washington measures inflation too generously. It assumes that people don't substitute similar goods when one thing gets too expensive.

The solution is to build a "chain" between each month's basket of goods to provide "a more realistic measure of inflation," Marc Goldwein explained. This "chained" index would offer a more accurate picture of what consumers are actually buying. But we're not just changing measures for measurement's sake. It would also save between $200 billion and $300 billion over the next decade by very, very slowly cutting Social Security and raising taxes.

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It's easy to see why a "more accurate" (i.e.: slower-growing) inflation measure would cut Social Security. Social Security recipients get a first check based on their life earnings. That check grows with inflation. Slower-rising inflation adjustments means slower-rising Social Security payments.

What does CPI have to do with tax revenue? Inflation touches wages, too: $50,000 in 1980 is $140,000 today. Nobody wants to tax middle-class families like they make 3X their income. So, as wages rise, the IRS raises tax brackets to keep up. But under a slower-growing measure of inflation, the IRS would keep up less. Some households would pass into higher brackets than they otherwise would. Their top dollars would be taxed at higher rates. Revenue would rise. Deficits would fall.

All told, chaining CPI would cut Social Security spending by about $112 billion in the next decade and taxes would go up by about $90 billion. The compounded savings, including on interest payments, would be about $300 billion. They would look like this:

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A GOOD IDEA?

Putting a chain on CPI has attracted support from Republicans who'd like to cut Social Security, Democrats who want to appear receptive to entitlement fixes, and moderates everywhere who argue that our current inflation measure is too generous.

They all might be right.

But while some have argued that "chained CPI" isn't a spending cut or tax increase, it's clear that the outcome of chained CPI is, unavoidably, spending cuts and tax increases. It cuts Social Security the most for the people who live the longest (they do tend to be richer) and it raises taxes moderately on workers who earn a wage that is close to a new tax bracket. There is a real risk that low-income seniors who live long lives could see smaller Social Security checks than they would today. But if this moderate and slow-moving deficit saver is the linchpin to an otherwise fair deal, Republicans and Democrats can do much worse than adopting a chained CPI.


This article available online at:

http://www.theatlantic.com/business/archive/2012/12/chained-cpi-the-sneaky-complicated-idea-that-could-end-the-fiscal-cliff-showdown-explained/266098/