The proposal to move to a "chained" Consumer Price Index (CPI) for making cost-of-living adjustments (COLAs) to Social Security benefits and indexing income tax is under discussion as part of the debt reduction talks. This proposal will reduce benefits for current and future retirees, while increasing their taxes.
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 COLA is to offset the Social Security beneficiary's additional expenses from one year to the next resulting from 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. 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 - so that the ability of some groups, such as seniors with health care expenses, to adjust and make substitutions becomes questionable.
In contrast to the chained CPI-U, the CPI-E was developed in 1982 to reflect the different spending patterns of consumers age 62 and older. The CPI-E has reflected a rate 0.3 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, reflecting 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.
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 will the change affect seniors?
Replacing the current CPI-W with the chained-CPI-U for purposes of calculating the Social Security COLA will 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 since December 2000. The Chief Actuary of the Social Security Administration estimates 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 $1400, a 9.2 percent reduction from currently scheduled benefits.
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. Moving to a chained CPI for purposes of indexing the income tax would 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 for Congress states 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 is 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 be expected to pay for the nation's fiscal mistakes.
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, the CPI-E represents a more accurate alternative for seniors. A COLA based on the CPI-E would ensure that seniors' buying power does not erode over time. If policymakers are concerned that the index does not account for substitution accurately, a chained CPI-E should be developed.
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, February 2013