CPI Change Would Affect Everyone
The consumer price index--a pivotal gauge of inflation in America--is likely to undergo substantial technical revisions as the result of a detailed new study concluding that the index consistently overstates the true rate of inflation. If the index is changed as the report recommends, there would be a dramatic effect on virtually every American, working or retired. But the repercussions, both direct and indirect, would vary widely depending on individual circumstances. In addition, although some changes could be implemented quickly, others would require acts of Congress.
What is the debate about? And how is it likely to affect you?
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Q: What happened and why?
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A: A blue-ribbon panel of economists, led by Stanford University economics professor J. Michael Boskin, was asked to study the consumer price index, which many seasoned experts have long criticized as overstating the true rate of inflation. The study, which spanned 18 months and whose results were released Wednesday, concludes that the CPI will, if not changed, overstate inflation by an average of 1.1 percentage points per year in the future.
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Q: Why would anyone care?
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A: Partly because of rampant inflation in the late 1970s, the index--originally devised in 1919 to help set wage rates for dockworkers--now affects cost-of-living increases for Social Security, veterans benefits and pensions for government workers. Many collective bargaining agreements and rental rate increases are tied to CPI changes, as are federal and state tax brackets, income tax deductions and exemption amounts. The CPI also affects eligibility for many welfare programs. And it’s a leading economic indicator, which means CPI changes are used to help central bank policymakers determine the direction of interest rates.
The bottom line: An inaccurate CPI enriches some Americans at the expense of others.
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Q: How would a CPI revision affect me?
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A: That depends on who you are and what you do. In brief:
* Taxpayers would pay more if CPI measures were revised downward because standard deductions, personal exemptions and tax brackets are indexed to the rate of inflation, as are deduction allowances for such popular tax breaks as 401(k) contributions. A lower CPI would mean that a more modest raise could push you into a higher tax bracket.
* Social Security recipients would get less because future cost-of-living increases would be based on lower numbers. But current recipients would be less affected because the CPI affects Social Security benefits in two ways: through the calculation of your initial benefit amount and through annual cost-of-living increases once you begin receiving benefits.
* Veterans and government workers would be likely to see their future retirement benefit increases curbed, just as Social Security recipients would.
* Doctors and hospitals would experience income losses because Medicare, the national health insurance system for the elderly, bases changes in medical reimbursement rates on CPI changes.
* Fewer people would qualify for public assistance and more would no longer qualify for programs such as Aid to Families With Dependent Children, food stamps and school breakfast and lunch programs. Eligibility for those programs is determined by comparing the applicant’s income with the federal poverty level, a figure indexed to the CPI.
* Poor working families would take a hit because eligibility for and amounts of the Earned Income Tax Credit (a refundable tax credit provided to the working poor) is indexed to inflation.
* Workers would be likely to get lower cost-of-living increases, says Dean Baker, economist with the Economic Policy Institute, a nonprofit research organization in Washington. Collective bargaining agreements often include cost-of-living adjustments tied to the CPI, which would be smaller in the future.
* Borrowers could see a long-term benefit because an inflated CPI may have artificially boosted the interest rates over time. Some analysts suggest long-term rates could fall by as much as 1 or 2 percentage points with a lower CPI.
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Q: So what happens now?
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A: The Bureau of Labor Statistics, the federal agency that compiles the CPI, is studying the Boskin report to come up with recommendations. BLS officials won’t comment on how they may respond, but several of the report’s recommendations--discussed with BLS officials more than a year ago--are already being tested and some will soon be implemented.
For instance, starting in January, the BLS will be using a different measurement of health-care costs, which is likely to produce significantly lower medical expense figures than in the past.
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Q: Does that mean that some changes could just go into effect without some sort of public or legislative debate?
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A: The BLS can implement many of the technical changes on its own authority. However, agency officials have publicly disagreed with some of the Boskin panel’s conclusions and are likely to refuse to make certain changes unless forced to by Congress.
For instance, according to the Boskin panel, a major component of CPI overstatement involves “quality bias.” In a nutshell, the report says that the cost of today’s color TV, which lasts longer and delivers a better sound and picture, shouldn’t be directly compared to the cost of an older TV. The BLS already discounts some price increases based on quality improvements, but placing a value on these improvements is a subjective process.
In addition, the Boskin panel found no compelling evidence to indicate that certain groups of Americans have a higher (or lower) cost of living than others, something many CPI critics have argued.
But the BLS has been compiling an experimental index, the CPI-E, which aims to track inflation experienced by the elderly. Although that index is flawed, Baker notes, it has consistently shown that older people suffer a higher inflation rate than the rest of the population.
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Q: Could increases in Social Security and government pension benefits be tied to the CPI-E then?
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A: Not under current law. Right now, cost-of-living increases for Social Security recipients are required to be tied to the CPI-W--the cost-of-living index for wage earners. Congress would have to change existing law to shift pension cost-of-living adjustments to a new index--assuming legislators determined that was the wisest course of action.
