The proposal in the House and Senate Republicans’ tax reform plan to move to a “chained” Consumer Price Index (CPI) to calculate increases in the tax code brackets and the standard deduction can only be seen as part of a broader plan to extend the use of this index when adjusting Social Security benefits for inflation.  It is the elephant’s nose under the tent.

For a number of years,supporters of the “chained CPI” have promoted the index as an option for reducing the deficit, balancing the budget and cutting Social Security Benefits for current and future beneficiaries.

Background

When automatic cost-of-living adjustments (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 COLA is to protect Social Security beneficiaries from the ravages of inflation.  Since then, the CPI-W has been adopted as the measure of inflation used to adjust a broad array of federal benefit programs, including veterans’ benefits, Supplemental Security Income benefits, and the tax brackets and other elements of the Internal Revenue Code.

Beginning in 2000, a new index became available – the “chained CPI.” 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. 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” does. However, not all “substitutions” are this simple.  For example, seniors with substantial out-of-pocket health care expenses would find making substitutions for these vital expenditures difficult if not impossible.

But more importantly, from the perspective of its advocates, the “chained CPI” yields a lower rate of inflation than does the CPI-W.  Wrapped in dense layers of statistical analysis, the “chained CPI” can best be understood by America’s seniors first as an increase in taxes and second as a stealthy cut in Social Security benefits.  In other words, a double whammy that anyone living on Social Security in recent years knows is unjust and unfair.

In contrast to the “chained CPI,” the CPI for the elderly, or CPI-E, was established in 1987 to reflect the different spending patterns of consumers age 62 and older. 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 particular medical procedure for a less costly alternative.  The National Committee supports basing future COLAs on a fully-developed CPI-E.

Finally, while the CPI-W is updated annually, the “chained CPI” 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 will the change affect seniors?

Replacing the current CPI with the “chained CPI” for purposes of adjusting the tax code brackets will mean tax increases for all Americans.  Extending the use of this index in calculating the Social Security COLA will reduce benefits for current and future beneficiaries. The “chained CPI” produces lower estimates of inflation than the current CPI does, averaging about 0.3 percentage points lower than the increases in the current CPI since December 2000.

The Chief Actuary of the Social Security Administration has estimated that after three years of enactment this reduced COLA would result in a decrease of about $130 per year (0.9 percent) in benefits for a typical 65-year old. By the time that senior reaches 95, the annual benefit cut will be almost $1,400, a 9.2 percent reduction from currently scheduled benefits. The cumulative effect of these reductions means that a 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.

On the taxing side, the effect also grows slowly over time, but is extremely impactful as well. In fiscal year 2018 about $700 million is projected to be raised, but grows to $27.8 billion by 2027.  In fact, adoption of the “chained CPI” has been estimated by the Joint Committee on Taxation to increase tax revenue by an estimated $128.2 billion over ten years[1].  This means that collectively, all Americans, including seniors, will pay more in taxes if the “chained CPI” is used in the future to adjust tax brackets in the Internal Revenue Code, and will cut Social Security benefits by even more if it is used to determine COLAs for retirees.

NATIONAL COMMITTEE POSITION

The National Committee opposes use of the “chained CPI” for calculating inflation adjustments for both the Internal Revenue Code and Social Security. For all Americans it’s purely and simply a tax increase.  And for Social Security beneficiaries it’s a benefit cut.  We believe both results are bad for America and bad for seniors.

 

Government Relations and Policy, November 2017

 


[1] Joint Committee on Taxation, November 3, 2017.