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Social Security reform: What 'chained CPI' proposal by Obama means

Obama proposes revising the way Social Security benefits get adjusted each year to help retirees cope with inflation, as part of 'fiscal cliff' talks. Here's how 'chained CPI' would alter the status quo.

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Cost of living adjustment (COLA). Many federal programs, including Social Security and the pensions paid to military veterans, are typically adjusted upward each year on the basis of inflation. 

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Chained CPI. Since 2002, the US Bureau of Labor Statistics has released an alternative inflation calculation called the chained CPI. It tends to find smaller changes in consumer prices than the bureau's traditional inflation index, because it accounts for the way consumers gradually adjust their habits of consumption as prices change. If beef gets a lot more expensive and chicken stays the same, consumers will tend to buy more chicken and less beef. 

Differences between the two inflation measures are small, often about 0.3 percent in a given year. But over time, the impact can add up. Basing the COLA adjustments on the chained CPI instead of on the traditional CPI would cut the typical 65-year-old's benefit by $130 per year, but after 30 years of retirement that person's annual income would be $1,400 less, says the National Committee To Preserve, Social Security & Medicare.

Supporters of the change say using a more accurate measure of inflation is a rational way to reduce a looming shortfall, as baby boomers retire.

Occupying a middle ground in the debate are some who argue that the change should be cushioned by supplementing benefits for older retirees.

"I think there is a good case for basing any COLA on what we may believe to be the most appropriate index of price changes," Eugene Steuerle of the Urban Institute said in congressional testimony last year. But he said it would result in a greater "front-loading" of the total benefits that people receive during retirement.

"If such an adjustment is made, it is more important than ever to offset such front-loading with a more back-loaded package of benefits," Mr. Steuerle said.

Obama's bipartisan Simpson-Bowles commission on fiscal reform called for using chained CPI in Social Security.
The Committee for a Responsible Federal Budget, a nonpartisan group pushing for deficit reduction, has outlined how chained CPI, coupled with other changes including a one-year boost in the eligibility age for full benefits and slower benefit growth for high-income Americans, could close Social Security's projected shortfall in coming decades.
 
If a shift to chained CPI were to occur across all government programs, it could affect the cost-of-living adjustments for veterans and federal retirees, and the number of Americans who migrate into higher tax brackets each year. 

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