The “chained” Consumer Price Index (CPI) for making cost-of-living adjustments (COLAs) was incorporated into the tax code with the 2017 revision of the tax law. It was a little-noticed provision that adjusts tax brackets and eligibility for deductions and has the effect of pushing more Americans into higher tax brackets more quickly.
The National Committee is concerned that, at some point, a proposal to use a chained CPI to calculate Social Security’s annual cost-of-living adjustment (COLA) may be considered an option for balancing the budget and cutting Social Security benefits. In fact, the House Republican Study Committee’s (RSC’s) FY 2019 Substitute Budget Resolution included switching to the chained CPI for the COLA, increasing the full retirement age to 70 and indexing it for life expectancy.
The RSC’s FY 2025 budget did not propose any specific changes to the formula for calculating Social Security’s COLA, but states that “a major part of the problem” confronting Social Security’s solvency “is the structure of Social Security’s Cost of Living Adjustment (COLA)”. The budget also criticizes the automatic nature of the COLA – with a clear implication that the RSC prefers returning to the days when COLAs were enacted on an ad hoc basis. Seniors, the disabled, survivors, and their families would, once more, be dependent on the ability and willingness of future Congresses and Presidents to increase benefits to help keep up with inflation. These proposals would reduce benefits for current and future retirees.
Background
When automatic COLAs for Social Security benefits were enacted in the 1970’s, there was only one CPI index available for use – the CPI-W, which reflects price increases for urban wage earners and clerical workers, based on a fixed market basket of goods and services. The purpose of the automatic COLA is to protect Social Security beneficiaries from the ravages of inflation without needing to rely on the ability and willingness of future Congresses and Presidents to increase benefits to help keep up with inflation.
Beginning in 2000, a new index became available – the chained CPI-U. This index is updated to reflect changes in spending patterns as prices increase on a month-by-month basis, as opposed to every two years in earlier indices. It reflects substitution patterns among dissimilar categories of items. For example, if the price of apples increases while the price of bananas remains constant and consumers respond by buying fewer apples and more bananas, the current index does not fully account for the substitution, while a chained-CPI-U does. However, not all the “substitutions” are this simple – for example, consumers forced to spend more on fuel, may spend less on food. The chained-CPI-U does not take into account the fact that the ability of some groups, such as seniors, whose health care expenses make up two to three times more of their budgets than younger households, may find it difficult, if not impossible, to make these substitutions.
In contrast to the chained CPI-U, an experimental CPI for the elderly, or CPI-E, was developed in 1982 to reflect the different spending patterns of consumers age 62 and older. Since it was created, the CPI-E has reflected a rate 0.2 percentage points higher than inflation as measured under the current method. This is primarily attributable to the greater weight placed on health expenditures in this index, revealing the continued rise in health care costs at a faster rate than other expenses. Seniors, of course, devote a higher percentage of their monthly spending to health care costs, and rarely have the flexibility to substitute one medication or medical procedure for a less costly alternative.
Finally, while the CPI-W and the CPI-E are updated annually, the chained CPI-U does not become final until two years after it is first published. Obviously, there are technical implications with using an initial number that could be revised two years later or waiting two years for a final number before applying a COLA.
How would the change affect seniors?
Replacing the current CPI-W with the chained-CPI-U for purposes of calculating the Social Security COLA would reduce benefits for current and future beneficiaries. The chained-CPI-U produces lower estimates of inflation than the current CPI does, averaging about 0.3 percentage points lower than the increases in the current CPI. As mentioned above, the current CPI produces lower estimates of inflation than the CPI-E, averaging about 0.2 percentage points lower. Thus, switching to the chained-CPI-U instead of the CPI-E to calculate benefits would result in a lower Social Security COLA of about 0.5 percent each year. The impact of such a reduction is cumulative – that is, the impact becomes greater with each passing year.
The cumulative effect of these reductions means that the disproportionate impact will be felt by Social Security’s oldest beneficiaries. These are often women who have outlived their other sources of income and rely on Social Security as their only lifeline to financial stability.
Younger beneficiaries, who have sources of income other than Social Security, may find themselves hit from another direction as well – increased taxes. Now included in the tax code, the chained CPI will reduce the yearly adjustments for personal exemptions, the standard deduction, and income thresholds dividing the tax brackets, thereby increasing the amount of taxes owed.
A Joint Committee on Taxation report prepared as the legislation was being considered by Congress stated that these increases would fall mainly on lower and middle-income taxpayers. For example, the tax liability for those with incomes between $10,000 and $20,000 would increase by 14.5 percent, and 3.5 percent for incomes between $20,000 and $30,000, while those with incomes of $1 million and above would see an increase of only 0.1 percent.
NATIONAL COMMITTEE POSITION
The National Committee opposes use of the chained CPI-U for calculating Social Security COLAs. This would be a benefit cut for current and future beneficiaries, pure and simple. Any discussion of Social Security should be off the table in debt reduction discussions. Social Security did not cause the nation’s debt problems and Social Security beneficiaries, who worked all their lives and paid into the system, should not have their benefits cut.
If the true reason for a change in the Social Security COLA calculation is to reflect changes in the cost of living more accurately, and not simply to reduce the nation’s debt, a fully developed CPI-E represents a more accurate alternative for seniors. A COLA based on a fully-developed CPI-E would ensure that seniors’ buying power does not erode over time.
There is no question that the nation’s debt problem must be addressed, but Social Security beneficiaries should not be asked to bear the burden of solving this problem when Social Security, with its self-financing framework, has not contributed to this situation.
Government Relations and Policy
Sources:
Bureau of Labor Statistics: https://data.bls.gov/pdq/SurveyOutputServlet