Senate Explores Plan to Restrict Inflation Hikes for Benefits : Congress: Some see politically charged issue as key to solving budget crisis.

Faced with an array of bleak trade-offs on the budget, members of Congress are exploring a plan to capture a cash windfall by limiting cost-of-living hikes for Social Security and other benefits.

Such a move, which has the blessing of many economists but strikes fear in the hearts of most politicians, would free several billions of dollars that could be used to cushion the tough spending limits sought for Medicare and Medicaid.

“If you want to get out of a protracted fiscal crisis that will go on for another generation--and spoil American politics--this is one of the few things you can do,” said Sen. Daniel Patrick Moynihan (D-N.Y.), who has called for the change.

Restricting the inflation hikes to one percentage point below the consumer price index, for example, could save a whopping $281 billion over seven years, Moynihan said.

In light of such prodigious savings, supporters tout the measure as the possible key to a budget agreement later this year.

Yet for all the pressure on congressional leaders to deliver on their budget promises without doing grave damage to Medicare, the cost-of-living proposal faces rigorous political hurdles. Cutting back on inflation increases would spark opposition from the defenders of Social Security, a formidable lobby. It would also raise taxes, because of the way the Internal Revenue Service incorporates the CPI in its tax calculations.

“If this is going to work . . . we’ve got to be in it together,” Senate Majority Leader Bob Dole (R-Kan.) said earlier this week, noting that such a controversial change would perish without strong bipartisan support.

But Dole also acknowledged repeated criticisms of economists that the CPI exaggerates the cost-of-living increases faced by ordinary households.

Earlier this month, a panel headed by Michael J. Boskin, former chief economist for the George Bush Administration, found in a preliminary report that the CPI overstates cost-of-living increases by perhaps one percentage point. It pegged the range of exaggeration at between 0.7 and two percentage points.

“It seems to me that this is something that should have [been] addressed years ago,” Dole said, although he did not endorse Moynihan’s proposal. The White House has been reserved and noncommittal on the idea, although Clinton Administration officials have not expressed total opposition.

Many economists agree that the CPI overstates the increases in living costs to some extent. For example, consumers are able to substitute cheaper products for more costly ones, if they wish--behavior that is not easily calculated by federal statisticians. Widespread changes in shopping patterns, such as the rising popularity of discount outlets, may also throw off cost-of-living estimates.

As a result, critics say, the government more than compensates for inflation in Social Security, military and civil service retirement and Supplemental Security Income for the elderly poor.

Correcting for that, however, has sweeping implications for everyone, not just those who receive government benefits tied to a cost-of-living increase.

Taxpayers generally could face higher tax bills because the IRS uses the CPI when it adjusts tax brackets to shield taxpayers from inflation. For example, a tighter cost-of-living index could mean less-generous personal exemption levels, thereby raising taxes.

Past efforts to freeze cost-of-living payments for Social Security, even temporarily, have triggered vehement protests and left members of Congress extremely wary about trying again. Moynihan’s proposed cost-of-living formula of CPI-minus-one percentage point could initially cost Social Security recipients about $20 a month, although the gap between what they get and what they would have gotten under today’s formula would expand over time.