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Politics, the federal deficit and the demise of the chained CPI

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The White House released information on February 20th to reveal some of what the administration's 2015 budget proposal will contain when it is actually released on or about March 4th.

The biggest news for many Americans, based on the information that has been released, is that the administration is dropping a proposal for a "chained CPI" that would impact those receiving Social Security and other federal benefits adjusted annually. The impact would have occurred by reducing how the benefits are calculated. In addition, under the president's proposal, spending would increase by about 56 billion. The administration usually refers to spending increases as "new investments."

This method of calculating future benefits would slow the growth rate in all federal payments adjusted annually for any cost of living increase. These include Social Security benefits, civilian worker and military pensions, and veterans' benefits.

What is the Chained CPI?

While the usual consumer price index (CPI) deals with the rise and fall in fixed items, a “chained CPI” would also consider choices people may make as a result of changes in their behavior. For example, if the price of beef goes up, many people will buy chicken instead because it may be a substitute that costs less. Also, when the price of a product goes up, people will probably buy less of that product.

The chain weighted CPI incorporates changes in both the quantities and prices of products. When it comes to calculating costs for multibillion dollar programs like Social Security, a chained CPI is likely to mean that benefit increases do not rise as much. Over time, benefits, payments, and pensions that are adjusted with CPI calculations could all fare differently under chained CPI rules.

Under the chained CPI, the annual increase to recipients would go down about .25% annually. It would also place taxpayers in higher brackets sooner than would occur if the traditional CPI measurement was used. For example, Social Security payments would continue to grow every year but over time the amount of money saved (and that would be lost by recipients) would continue to grow. By 2030, the median payment would be 3% less than it would be if today's inflation measure were used.

What Would the Chained CPI Cost?

Changing the way in which the annual COLA for Social Security is calculated would save the federal government a significant amount. Switching to a chained CPI could reduce spending over 10 years by $216 billion and raise $124 billion in revenue, according to the Congressional Budget Office. That would mean total deficit reduction of $340 billion, before counting interest savings.

The cost would obviously vary according to the amount of benefits received. The AARP posted a calculator to demonstrate how much it would cost Social Security recipients. According to this calculator, a 66 year old receiving $14,800 per year in benefits would lose $645.34 over a five-year period. The calculator includes a convenient link with a pre-written note to the appropriate Members of Congress to protest the change.

The change would also impact federal employees. An article published on February 20th calculates the potential cost of the chained CPI for a retired federal employee receiving $1000 per month to be about ten cents per day. The author concluded with: "My 'devastating' loss due to the chained CPI will be slightly less than one pizza per month."

However, a federal retiree who received $50,000 per year in federal retirement payments would lost about $1456 per year over five years and $23,518 over 15 years.

Politics and the Federal Budget

The current national debt total now exceeds $17 trillion and this amount is going up every day. The total of this deficit now exceeds $150,000 per taxpayer. Moreover, the increasing deficit created by federal spending is continuing to go up rapidly. The federal budget deficit will total another $514 billion in fiscal year 2014 according to the Congressional Budget Office (CBO).

But, as happened in Greece and in other countries that have spent considerably more than the government receives in revenue, any proposed budget cuts result in a political kerfuffle. The chained CPI is one example. We have not experienced the riots that have happened in Europe over proposed budget cuts although, in all likelihood, we have just not reached the political and economic pressure points that will require more substantial and more damaging cuts in the future as interest rates rise and the federal deficit goes up dramatically as a result. An increase of one percentage point higher inflation each year could add almost $900 billion to deficits over a ten year period. Higher interest rates--as in the 1981-1990 experience--could add about $1.1 trillion more to cumulative baseline deficits. Interest rates as we experience from 1982-1990 would add about $5.4 trillion.

Interest groups representing senior citizens, federal employees, and others rushed to the internet and the telephones to protest any cuts in their benefits. As is often the case, these efforts were successful. No one wants to lose more money to taxes or to smaller benefits. And, once a system is in place, a politician that dares to suggest benefits are too expensive or have too much of an impact on the federal budget, the opposition will show up in force to prevent the change.

Most politicians are, of course, sensitive to public disputes which can turn into losing a future election. The result is usually a call to increase taxes on "the wealthy" or "the rich" or some other amorphous group that, in theory at least, is not paying "their fair share" and is a target for paying more taxes to finance the unbridled federal spending.

The bottom line is that the politicians want to soothe the economic hit on the smallest number of people and, if necessary, demonizing people that are more successful to support tax increases. So far, the result has been little in the way of long-term deficit reduction and continuing to hope that the problem will be resolved with a growing economy and higher government revenue.

No one wants to pay more or see their federal benefits reduced by any amount. As we have seen from the turmoil in Europe in countries facing bankruptcy or default on government debt, this is a typical reaction that we can expect whether in the U.S. or abroad. There is little agreement on how federal spending should be cut or even if federal spending should be cut. Republicans generally want to decrease federal spending and avoid further tax increases. Democrats are generally opposed to cuts in spending and, as seen in the president's outline of a 2015 budget, would prefer to increase both taxes and spending.

As a result, it is not surprising that the president has now abandoned the proposal to adopt the chained CPI and to increase spending on the issues of more interest to his political interests. The CPI issue is unlikely to advance at all during an election year and the issue of how to deal with the increasing deficit will be ignored until a later time when circumstances and political pressure will require some significant and economically painful steps to be taken in order to preserve the stability of the government.

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