Bloomberg View

Bloomberg View: A Bipartisan Deficit Fix


Bloomberg View: A Bipartisan Deficit Fix

Illustration by Bloomberg View

Congress and the White House seem incapable of agreeing on substantive measures to tackle the $10.4 trillion mountain of U.S. debt. There is, however, one long-overdue piece of important business that can and should get done: the adoption of a more accurate gauge of U.S. inflation. Such a fix would yield immediate savings and help put the economy on firmer ground. It’s already been endorsed by lawmakers in both parties, the Obama administration, many economists, and a series of bipartisan deficit-reduction panels. Best of all, it would help shore up Social Security. Trustees for the retirement fund projected on April 23 that it would run dry in 2033, three years earlier than last year’s forecast.

It has been widely recognized for almost two decades that the current measure of inflation, the consumer price index, contains several biases that cause it to overstate inflation by anywhere from 0.3 percentage point to 0.8 percentage point, depending on which expert you talk to. The CPI is the benchmark that determines cost-of-living adjustments for a wide range of government programs, including Social Security and federal employee pensions. It’s also used to peg income tax brackets, exemptions, deductions, and credits.

To calculate the standard CPI, Bureau of Labor Statistics employees shop for a market basket of 80,000 goods and services that are weighted to reflect consumer spending patterns. Since 2002 the BLS has also compiled a different index, called the chained CPI, which is a more exact measure that accounts for the substitutions consumers make when a product’s price goes up. A shopper might respond to a rise in the cost of Granny Smith apples, for example, by switching to lower-cost Red Delicious, a process known as lower-level substitution. Or a consumer might react to a price increase in one item by switching to another category altogether. (Buying less expensive oranges, for instance, instead of pricier apples.)

While the standard CPI largely maintains the same basket of goods regardless of price changes, the alternative measure more accurately models substitution behavior by “chaining” two consecutive months of price data. It also adjusts the weights to account for a decrease in purchases of the more expensive product and increased purchases of the lower-cost substitute. (More oranges, fewer apples.)

On average, the BLS’s chained CPI has been 0.25 percentage point to 0.35 percentage point lower than the standard CPI. Switching to the alternate measure would produce as much as $300 billion in savings and revenue within a decade. The Congressional Budget Office has estimated that using the chained CPI to set cost-of-living increases for Social Security alone would save $112 billion from 2012 to 2021. An additional $33 billion could be saved by applying the measure to other federal spending.

The switch would also mean that many wages would rise faster than the new inflation index, pushing people into higher tax brackets and producing as much as $90 billion in new revenue over 10 years. It would also reduce interest payments on the debt by as much as $44 billion.

The adoption of the chained CPI has been an element of every serious bipartisan deficit-reduction plan of recent years. It also was among the ideas very nearly agreed on during last summer’s debt-limit negotiations between the White House and House Republicans. A vigorous debate has erupted over just how much inflation—if any—is desirable or tolerable in our economy. But that discussion is separate from the important step we are recommending: Let’s make sure the measure we use is accurate.

To read Simon Johnson on the euro’s future and Al Hunt on Newt Gingrich's last hurrah, go to: Bloomberg.com/view.


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