Wednesday, November 09, 2011

Hidden Politics Inside Number-Crunching

You wouldn't think that the way we measure inflation in various price indexes could be used to cut back on federal spending in a way which the politicians hope remains hidden:
Just as 55 million Social Security recipients are about to get their first benefit increase in three years, Congress is looking at reducing future raises by adopting a new measure of inflation that also would increase taxes for most families — the biggest impact falling on those with low incomes.
If adopted across the government, the inflation measure would have widespread ramifications. Future increases in veterans' benefits and pensions for federal workers and military personnel would be smaller. And over time, fewer people would qualify for Medicaid, Head Start, food stamps, school lunch programs and home heating assistance than under the current measure.
Taxes would go up by $60 billion over the next decade because annual adjustments to the tax brackets would be smaller, resulting in more people jumping into higher tax brackets because their wages rose faster than the new inflation measure. Annual increases in the standard deduction and personal exemptions would become smaller.

There are problems with almost any price index you care to construct, and the reasons for changing the current one are these:
The inflation measure under consideration is called the Chained Consumer Price Index, or chained CPI. On average, the measure shows a lower level of inflation than the more widely used CPI for All Urban Consumers.
Many economists argue that the chained CPI is more accurate because it assumes that as prices increase, consumers switch to lower cost alternatives, reducing the amount of inflation they experience.
For example, if the price of beef increases while the price of pork does not, people will buy more pork. Or, as opponents mockingly argue, if the price of home heating oil goes up, people will turn down their heat and wear more sweaters.
A report by the Moment of Truth Project, a group formed to promote the deficit reduction package produced by President Barack Obama's deficit commission late last year, supports a new inflation measure. "Rather than serving to raise taxes and cut benefits, switching to the chained CPI would simply be fulfilling the mission of properly adjusting for cost of living," it argues.
At the same time, the current CPI for All Urban Consumers is not a terribly good measure of the cost of living for older Americans. That is because the "standard shopping basket" (i.e., a representative consumer budget) the index uses is not that close to the standard "shopping basket" of the elderly.

As discussed in this government publication, the elderly buy more medical care and shelter than the standard basket contains. Because the prices of medical care and shelter have risen faster than the general price level, the cost-of-living increases for the elderly may not be adequately reflected in the current CPI for All Urban Consumers.

Is that boring enough for you? The point I'm trying to make is this: Sure, the current CPI may be overestimating price increases in general because people adjust what they consume based on the price changes, so the old standard shopping basket is no longer relevant.

But at the same time, the current CPI may underestimate the impact of price increases on older Americans. If we are going to fix the former problem and not the latter, lots of frail old people could suffer.