The Bureau of Labor Statistics defines the consumer price index as a “measure of the average change over time in the prices of consumer items – goods and services that people buy for day-to-day living.”
Traditionally, CPI (technically CPI-U, the consumer price index for all urban consumers) was considered an upper bound on a cost-of-living adjustment because it did not reflect the changes in consumption patterns that consumers make in response to changes in prices between item categories. For example, if the price of pork increases while the price of beef decreases, consumers might shift away from pork to beef. CPI takes into account a modest amount of substitution within item categories but not substitution between categories.
What is “chained CPI”?
Chained CPI is calculated using a formula that reflects the effect of substitution that consumers make across item categories in response to changes in relative prices. In the pork vs. beef example, chained CPI would rise, but not as much as CPI that is based on fixed purchase patterns and does not take into account substitution between categories.
How would social security benefits be affected by a change to chained CPI?
Social security benefits (and many other government payments and pensions) are adjusted by a cost-of-living allowance (COLA) for inflation to take into account the rising cost of goods and services. To the extent a lower measure of inflation—such as chained CPI—is used instead of CPI to calculate the amount of the adjustment, social security benefits would increase more slowly.
According to Frequently Asked Questions about the Chained Consumer Price Index for All Urban Consumers published by the Bureau for Labor Statistics, in each of the past four years (including 2004 for which the chained CPI values are not final), the difference in December-to-December changes between CPI and chained CPI was 0.3 or 0.4 percentage points.
What tax provisions would be affected by a change to chained CPI?
Many tax provisions, including the tax rate “brackets,” are indexed for inflation using CPI. A change from CPI to chained CPI would result in an increase in taxes over time.
What would be the revenue effects of a change to chained CPI?
Official estimates of the change to chained CPI from CPI over a 10-year period resulting from lower benefit payments and higher taxes are not yet available. However, the effects could be substantial.
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