Chain-CPI Short of Solution Short on Vision

Originally Published On Forbes

While there is generally agreement across a broad range of the political spectrum that Social Security is unsustainable in its current form, there is less consensus about what to do to assure long-term stability.

Most democratic policy makers, including Presidential contender Joe Biden, would increase tax revenue available for benefits by raising the wage base — the amount of earnings subject to Social Security taxes. (For 2020, that amount is $137,700.) Others would like to contain the costs of the program. Various bipartisan proposals would do both.

For those focused on the expense of the system, one of the favored approaches is to change the measure of the cost-of-living adjustment, or COLA. The COLA is an essential component of the program. Under current law, Social Security automatically increases benefits annually based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to offset the impact of inflation. Reformers would change that process to use the Chained CPI for Urban Consumers (C-CPI-U) to offset the rise in the cost of living.

According to the SSA this policy option would address about 20% of the shortfall.

Long Range Solvency Provisions

The appeal of the shift of the COLA to a C-CPI-U to the spend-less-crowd is easy to understand. It saves money. The Congressional Budget Office estimates that this policy option would save the system more than $100 billion over the coming decade. That savings comes disproportionately from those with the highest benefit levels. Moreover, supporters of the change sell it as a more accurate

measure of inflation than the current index used. If you listen long enough, the solution not only makes the system more stable, but actually improves the inflation adjustment process.

The problem is that C-CPI-U is not a better measure of inflation. The index does not even measure true inflation. It actually measures the cost of living, which in part reflects the behavioral response to inflation.

To illustrate the impact of behavioral response, two years ago the rising cost of health insurance forced me to switch to a less expensive alternative. In order to keep my new insurance cost roughly the same as my old cost, I had to double my deductible. In my case, it is possible to say that my cost of living hasn’t changed ---assuming, that is, I don’t have medical costs that force me to pay the full higher deductible. But it is insane to say that there was no inflation in healthcare that year.

While it is true that in any year the savings from switching to C-CPI-U will come disproportionately from those receiving the biggest Social Security checks, there is nothing to suggest that these people are particularly well off. Moreover, data from the Social Security Administration suggests that the large reductions from this policy option may well come from those most in need because the relative importance of Social Security benefits to recipients’ overall living standard rises with age.

As people age, most beneficiaries have fewer work options and have used up some, if not all, of their retirement savings to cover costs that go over the level of benefits. As a result, we tend to depend on Social Security benefits for a greater percentage of our total income as we get older.

The Social Security Administration's statistics support this thesis. Social Security benefits account for 90% or more of income for more than 1/3rd of seniors. That percentage of seniors who fall into that highly Social Security dependent group nearly doubles between the ages of 70 and 80. This trend is a great concern because a typical retiree can expect to live to 85.

Unfortunately, the impact of lower COLAs accumulates over time. So the chained-COLA would apply progressively larger reductions to people as they age. For example, FactCheck.org reports that a reduction of .25% in the annual inflation adjustment will lower the buying power of a retiree’s monthly check by 3 percent after 10 years. By the time that retiree is 95, the lower COLA adjustment will have cut the value of the check by 8 percent, relative to what he would have with a COLA that is 0.25% a year larger.

I am not going to tell you that CPI-W is the correct measure. The fact is that there isn’t a single best measure for inflation. Inflation is a theoretical concept that varies by person and by location. Some argue that an experimental index which takes into account the spending patterns of those 62 and older (CPI-E) is a more accurate benchmark for Social Security. Among other things, it reflects the higher share of their spending which goes to medical care, where costs have been rising faster. Using CPI-E would tend to make Social Security benefits increase faster.

Bottom line: the shift to a chained-CPI would fix our old-age insurance program with a solution that lowers the buying power as one ages. This option is like buying auto insurance that declines in value as the car wreck gets worse. Fixing Social Security's finances in the most responsible manner requires that we look at more than just how much a change will save.