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What is Chained CPI?

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Inflation - Worthless Zimbabwe 250mm billIf you saw President Obama’s FY2014 budget, one of the biggest pieces of news in it was a change in the calculation of the cost of living adjustment, or COLA. COLA is used to figure out how much to increase many government payments, the most important of which, especially for retirees, is probably Social Security payments. The switch from the current inflation measure to what is known as “chained CPI” is estimated to reduce the federal debt by $230 billion dollars ebacuse chained CPI is expected to grow between 0.25% – 0.30% slower than the CPI they use now.

As is the case with any small percentage, the initial impact would be small and grow over time. As the years pass, the impact would be greater. “According to the National Women’s Law Center, a retiree who was collecting $17,520 last year would see 6.5% less, or $1,139, by age 85, if chained CPI were adopted now. A decade after, their payments would be 9.2% smaller, or $1,612.”

So what is Chained CPI?

What is Chained CPI?

Isn’t that the million dollar question? Chained CPI, or C-CPI-U, is a relatively recent measure (August 2002 was the first release) and the big difference is that it takes into account how people substitute products in response to price changes. The BLS has a more in-depth explanation, the term Tornqvist formula is used, but the basic gist is that when prices increase, people don’t always just pay more for the same products. They pay for cheaper versions or otherwise make what they have last.

Chained CPI is designed to capture this and it’s the reason why it grows at a slower pace than CPI-U. I didn’t look into the calculation or the data inputs but the explanation made sense. In theory, Chained CPI should be more accurate since it models more closely consumer behavior but as is the case with any measure, the devil is in the details.

What is used now?

There are several CPI figures and the one that most people talk about is CPI-U, or the Consumer Price Index for All Urban Consumers. Interestingly enough, Social Security’s COLA uses CPI-W. CPI-W is the Consumer Price Index for Urban Wage Earners and Clerical Workers. The CPI-W is a subset of the CPI-U and according to the, CPI-W covers 32% of the U.S. population while CPI-U covers around 87%. The theory goes that the CPI-W is used for many COLA adjustments in labor contracts so they used it for Social Security.

Is this a good thing?

It depends on where you’re standing. If you collect payments, the answer is clearly no. You’ll get less because COLA adjustments will be smaller. If you make payments, the answer is clearly yes. You pay less because COLA adjustments will be smaller.

Is it fair? That depends on your confidence in the accuracy of C-CPI-U … but no one ever really cares about “fair.” It’s always about how it impacts you so it’s a moot point.

(Photo: ZeroOne)

{ 15 comments, please add your thoughts now! }

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15 Responses to “What is Chained CPI?”

  1. NateUVM says:

    This basically comes down to whether or not you are okay with getting less from SS.

    My understanding of SS has been that it mirrors a defined benefit plan. That you put a certain amount in, and when you retire, someone (in this case, Uncle Sam) guarantees you a certain amount in benefits. That, no matter what the investment performance of the funds that you have contributed, there is a certain hurdle that the guarantor has to get over in order to fullfill their promise.

    Sometimes the contributions cover the benefit. Sometimes they don’t.

    In the case of SS, we are starting to run into a situation where, for a variety of reasons, long-term, those returns are not going to cover the benefits.

    This isn’t really anyone’s fault. People are living longer. There are fewer workers per retiree. Returns aren’t as much as they used to be. Constructively, who can you blame for this? I’m not sure you can.

    But it needs to be fixed, right? You can’t just promise a benefit and then…not give it.

    The reality is, the historical level of contributions do NOT cover the same level of benefit. So, unless people want to start contributing more, the benefit level promised NEEDS to be decreased.

    Chained CPI is one way to accomplish this.

    Some other ways involve raising the retirement age, or decreasing eligibility. But those measures seem relatively aribitrary and would need futher adjustment as future changes in demographics, etc… occur.

    Changing the COLA calc to Chained CPI is something that is truly transformative to the calc, and won’t require additional action to increase its effect over time as circumstances continue to change (its effect grows over time as the difference in benefit levels promised between the two methods grows). And we’ve all seen how painful making ANY changes has been, lately…

    And while one could argue it’s accuracy, the theory that Chained CPI describes inflation better means that there is an attempt to be MORE accurate, which is an attempt to be MORE fair. Not sure what else you can ask for in this situation.

    • Thomas says:

      This is actually a wolf wearing sheep’s clothing and an easy way out for the feds. The elderly or disabled who collect social security, are very often ill, have therapy requirements, medical requirements, dietary requirements etc. All of these items do increase in price every year, if not more, for inflation and increased cost of production and sales. For the vast majority of these items the consumer can not just purchase a cheaper one as if they were buying underwear. These intellectuals will also find that for many of these individuals, these items are the majority of their expenses. Many of these individuals will go for a long length of time without purchasing new clothing or new household items due to the fact that the majority of their expenses are the items mentioned previously. Therefore, the Chained CPI will increase the expense to income ratio and not decrease it making these individuals poorer every year. Many of these individuals are already at the poverty line and the Chained CPI will make them even impoverished.

  2. Shirley says:

    As a retiree on SS… ouch!

  3. David says:

    They need to do this (unless someone has other suggestions?), maybe more, to keep SS solvent and a bit more fair, intergenerationally. I can’t find the SS report, but current retirees are getting $1.31 in benefits for every dollar they put in, while if things remain unchanged, folks who will retire in 2030 or 2040 will get about 75 cents on every dollar. Agree with NateUVM.

  4. Judith says:

    those who advocate for chained CPI either mistakenly assume that everyone on Social Security CAN substitute or cut down on their spending for food, clothing, shelter, medical and other necessities without suffering considerable hardshsip — or they don’t care about the suffering and hardship.
    A great many people on SS are already at the edge — barely subsisting on a minimal amount of the cheapest of foods, living in the tiniest barely habitable space, not even dreaming of a luxury like dental care, etc, etc. So when chained CPI assumes thy’ll cut down, what chan they do? No more tuna or rice and beans — there’s always cat food, begging or dumpster diving. No more tiny room at the boarding house, here’s a nice cardboard box to stay in under the bridge.
    Those living one notch up from destitution today, newly unable to afford their modest apartment due to chained CPI, can then move into the newly vacated tiny room, but they’d better be prepared to move under the bridge NEXT YEAR, when chained cpi pushes them further down the financial drain!
    And those two notches up can only look forward to joining them under the bridge in two years time…..and so on.
    So chained CPI would insure that, not only will the standard of living never get any better for a senior, but that a senior’s standard of living will inevitably DECLINE for each senior year after year after year….
    A very grim outlook for all.
    Chained CPI would result in an inexorable, downward spiral of suffering and despair, leaving a great many seniors and the disabled with no hope of brighter days or an occasional chicken in their pot EVER.
    It was that kind of hopelessness and helplessness that social security was designed to eradicate so many decades ago.
    Do Americans still care enough to prevent that kind of destitution and despair?

    • Mike says:

      Is that your idea of reasoned debate – an emotional plea for the poor starving retiree?

      I think that the picture you paint represents a tiny portion of the retired population. I DO have compassion for those who, through no fault of their own, are in desperate straits. However, in my experience, the people who are bleating most loudly left the workforce voluntarily and as soon as they could, without taking responsibility for their retirement years. I have little sympathy for someone who works 25 years and does not have the foresight to save for their retirement. SS is NOT a retirement program, people!

  5. freeby50 says:

    Personally I think this is fair. Nobody promised anyone fatter COLAss than the norm and using CPI-W is actually better than the standard CPI-U. This is a pretty small incremental change really. Yes it adds up over 10-20 years but its not like they’re slashing benefits, they just won’t grow quite as fast as they had.

    Of course retirees won’t like getting smaller increases.

    One way or another we have to change benefits and/or increase taxes at some point.

  6. elloo says:

    Only someone under 62 would think up this mess.

  7. NateUVM says:

    @ Thomas – SS is a retirement benefit, to help cover income that is lost at retirement. It is not a medical care/treatment supplement.

    You have discussed the reality of being older in our society, but they are issues that SS was not intended to address. Separate accommodation should be made for those issues.

    Maybe a single-payer system…?

    Again, different topic.

    • Thomas says:

      SSDI is a social security income replacement for those who are disabled and unable to work. It is a social security income only provided if the disable individual had contributed to social security via employment in the past.
      It uses the same COLA currently and will be converted to Chained CPI in the future. Social Security Disability Income follows the same regulations as Social Security Retirement Income. It is just that one is for disabled individuals and the other is for retirees. Also, many retirees have similar difficulties as the disabled in reference to excessive medical and therapy cost etc. Both the disabled and the retired individuals will suffer even more than they currently are with the Chained CPI.

  8. NateUVM says:

    @ elloo – The under-62 crowd is probably the only population that would be affected by any change. I haven’t read text of the actual proposal, but I would be surprised if there weren’t some sort of phase-in installed (i.e. Over-55 => Old CPI; Under-55 => Chained CPI).

    Either way, even if there were no phase-in, the nature of the change means it will affect the younger more than the older as the impact grows over time. Sort-of strips away the generational bias.

  9. NateUVM says:

    I understand the problems with potentially reducing the payout. This is a benefit that serves a highly vulnerable population. Changes like these need to be made with GREAT consideration for the impact, both now and in the future, that this will have.

    But what are the alternatives? Do nothing and let the whole thing collapse? For those that have made great arguments against using Chained CPI…

    What is your solution?

  10. julie says:

    I read Al Gore’s book The Future; which substantiates my suspicions. I no longer have faith that government is looking out for the ‘little man’; it is taken over by corporations. The government can no longer afford to keep its promises, this is another tool to pretend that it is when it really isn’t.

    Retirees can no longer count on social security, company pension or their money not losing value.

    We must be more resourceful somehow!


  11. julie says:

    Having just finished Al Gore’s book The Future, I am validated in my suspicion that the government is no longer looking out for the ‘little man’. It is being taken over by corporate interests.

    We can no longer count on social security, company pension or the sustainability of the value of money in our retirement.

    We must be more resourceful somehow and make do. And when we make do, we get compensated less with the new ‘chained cpi’…and so we become even more resourceful…how does this cycle end?

  12. NateUVM says:

    @ Julie – “We can no longer count on Social Security…”

    That’s exactly the point, Julie. We are being trained to manage without. But I think that is fine. When SS was established, it was because people were caught woefully unprepared for an economic situation that was thrust upon them. Something HAD to be done.

    Now? There are generations of Americans who have grown up with those horror stories of 1) parents having lived throught the depression without savings and doing their best to get by and 2) a future without SS, or a potentially fully funded SS, anyway.

    If we haven’t gotten the message that we need to be mostly responsible for our own savings and retirement needs by now, I’m not sure when we will. We have the tools to do it, it’s just a matter of putting them to use.

    And again, while I would nominally be in favor of NOT changing the SS COLA calc, I am forced into the realization that SOMETHING needs to be done.

    So, again…because I still don’t see any suggested here… The system needs to change in order to survive… What are YOUR solutions?

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