Leave the Consumer Price Index and Cost-of-Living Adjustment Out of the Budget Talks

December 12, 2012

House Republicans have made switching from a regular consumer price index (CPI) to a chained CPI the centerpiece of their deficit reduction proposals, says Stephen J. Entin, a senior fellow at the Tax Foundation.

  • The CPI adjusts various federal tax and spending formulas for inflation.
  • Republicans advocate this because the chained CPI has risen about half percent less each year than the regular CPI.
  • The hope is that the switch would slow adjustment of income tax brackets for inflation and reduce annual cost of living increases (the Cost-of-Living Adjustment, or COLA) for Social Security retirees.

Some people argue that fixing the CPI and COLA will fix the projected deficits that Social Security faces. However, that is not the case as there are many other factors that contribute to Social Security's potential insolvency.

  • First, the demographic shift as baby boomers retire, as well as an increase in life expectancy, will mean there is a smaller ratio of people working to receiving benefits.
  • Second, the initial benefit formula -- consisting of several factors that determine each person's initial monthly benefit check -- is going to allow benefits to rise for people across the board.
  • As a result, retirees are going to receive higher benefits despite being rich.
  • Additionally, changes in the COLA won't change the initial benefits that future beneficiaries receive. Switching to a chained CPI would reduce COLA by about half percent a year.
  • This amounts to an average of only a 5 percent reduction over the life of a recipient.

Moreover, the switch to a chained CPI would push people more quickly into higher tax brackets. For instance, people in the 15 percent bracket would be pushed into the 25 percent bracket faster. This is, in effect, a tax rate hike in disguise and undermines the progressive tax rate structure that makes people with higher incomes pay more tax.

In addition, the regular CPI prevents the real wage gains of taxpayers from turning into a "real bracket creep." Under a chained CPI, much of the workforce could end up in the top tax bracket, curbing economic growth and threatening jobs around the country.

Instead, amend the benefit formula and/or raise the retirement age in an effort to slow the growth of benefits. One proposal, progressive price indexing, would allow some wage-adjusted growth at the bottom bracket in the benefit formula while adjusting the benefit formula for the top bracket to raise lower income benefits relative to upper income benefits.

Source: Stephen J. Entin, "Leave the CPI and COLAs Out of the Budget Talks," Tax Foundation, December 6, 2012.

 

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