A chained CPI (Consumer Price Index) sounds like a very painful condition. Or it sounds like a price index that couldn’t be controlled and is therefore forcefully restrained. Thankfully, it is neither of these situations and is instead a more realistic way of assessing cost of living increases. As a small scale example, assume that the price of broccoli increases dramatically. If you assume that you will buy the same amount of broccoli as before, the impact of this price escalation will be far greater than if, given the broccoli price increase, you move decisively into having more green beans as part of your diet. In reality we make substitutions as prices of certain products escalate in comparison to other products. I have been very careful in my example, not to use dark chocolate because for a true chocolate lover it is inconceivable to substitute out of chocolate.
As Washington continues to grapple with sequestration, the White House is proposing limited cost of living increases in indexed social programs by substituting the chained CPI for the set market basket CPI presently in use. I think this makes sense. We do substitute, when possible, out of products that have increased in price to products that serve the same purpose but are more reasonably priced. And the impact is to moderate the price increase for our (slightly) revised market basket.
Any alternative we can contemplate to the present rigid sequestration formula will require spending reductions along these lines. The Simpson Bowles Moment of Truth Project has endorsed moving to a chained CPI. Given the impact of the CPI on Social Security and other benefits, their estimate is that this more accurate measure of inflation “would save $390 billion over a decade - $215 billion from spending, $125 billion from revenue, and $50 billion from interest savings.” They also estimate that the second decade savings “would reduce the deficit by over $1 trillion…” and “would reduce Social Security’s 75-year funding gap by one-fifth.” A chained CPI is also considered, for the most part, to be “distributionally neutral” with a similar percentage impact across various income levels.
The chained CPI proposal has the endorsement of not only the White House but also of the House of Representatives leadership. Where there are still differences is what will accompany the chained CPI In the deficit reduction legislation – will it be further cuts in spending or will it be further increases in taxes. Both parties are in a difficult position in regard to this issue. The Republicans would be hard pressed to support an additional tax hike and the Democrats would be hard pressed to reductions in benefits without further tax increases. But to the extent that each party will have to move so that this key part of any solution falls into place, we should have that movement now so that the economic recovery is the clear beneficiary and we have moved forward in a most meaningful way in reducing the deficit.