Real Clear Markets

A Fiscal Cliff Compromise Through Alternative CPI?

President Obama and Speaker Boehner have reportedly agreed to support a change in the price index used to adjust Social Security benefits for inflation. Such a shift is therefore likely to be part of any deal to avoid going over the fiscal cliff. What is this proposal? Is it a good idea?

The idea is straightforward. All retirement, disability, and survivors pensions are adjusted each year to offset inflation as measured by the consumer price index (CPI). Studies have indicated that the particular version of the CPI now in use somewhat overstates actual inflation. An alternative index would be more accurate and would grow a bit more slowly—by about 3/10 of 1 percent less per year—than the current index does. In its most stripped down form, the proposal would apply to the annual inflation adjustments in Social Security benefits. But the swap could also apply to other federal expenditures, such as Supplemental Security Income (SSI), the program of cash assistance to the very poor, and to provisions of the personal income tax, such as the standard deduction, personal exemptions, and bracket widths.

One’s judgment on use of the alternative index should depend on how broadly it is applied. If the answer is that the new CPI would be used just for expenditure programs, but not for taxes, it is a truly terrible proposal and should be regarded as a ‘deal breaker.’ If the alternative CPI is used for Social Security and for tax provisions, it is still a dubious proposal, but would be an acceptable component of a larger budget deal that resolved the multiple uncertainties called ‘the fiscal cliff.’

From a purely technical standpoint, most analysts agree the alternative CPI measures inflation better than the current index does for most Americans. Whether it is a better measure of inflation for the elderly is less clear. A special price index based on the market-basket that the elderly on average consume indicates that the prices of those goods actually grow somewhat faster, not slower, than the current CPI. So, if one is engaging in a green-eyeshade exercise in which the only objective was technical accuracy, the case for the alternative CPI is not clearly correct. The special price index for the elderly might make more sense for adjusting pensions. On the other hand, the alternative, more-slowly-growing index might make more sense when adjusting provisions of the tax code which applies to people of all ages.

But this debate should not be about the formal properties of price indices. It should be about whether the substantive impact of the resulting changes in pensions the retired and disabled receive, in the amount of assistance available to poor SSI recipients, and the amount of taxes that people pay.

The impact of the alternative index on Social Security would be deplorable. The small annual cuts would cumulate, growing larger the longer one is on the benefit rolls. It would hit hardest the very old and the long-term disabled. People who come on the disability rolls at age 40 would lose nearly a full months benefits each year by the time they reach age 65. The same would be true of retirees by the time they turn age 87. Poverty among the elderly tends to increase with the age. Cutting benefits more each year for those whose economic condition has deteriorated most is perverse. That is true whether or not the instrument of such perversity is a ‘technical’ improvement.

The effects of cutting the price index used to update SSI benefits are more complicated but are even worse. Half of SSI recipients are also Social Security beneficiaries. These are people whose Social Security benefits are even lower than the meager SSI benefit. For these poor elderly and disabled people, SSI brings not just a bit of cash, but also eligibility for Medicaid, which pays medical expenses not covered by Medicare. These expenses include premiums, deductibles (now$1,156 for a hospitalization), and other cost sharing. If a switch to the alternative price index slows the growth of SSI benefits, some who now qualify would lose SSI eligibility. Because Medicaid eligibility is often contingent on SSI eligibility, some people of very modest means would abruptly face sharply increased out-of-pocket medical costs. If, as both parties have agreed, the poor should be spared undue burden from deficit reduction, SSI benefits should not be cut.

Mr. Boehner has now accepted the truth, long recognized by budget analysts, that higher taxes must be part of any politically viable deficit reduction program and any package to avoid going over the fiscal cliff. The switch to the alternative price index for adjusting the standard deduction, personal exemptions, and bracket widths would generate additional revenues across the income spectrum. In this case, improving technical accuracy achieves a substantively necessary objective.

So, the bottom line is that applying the alternative price index just to Social Security is a bad idea. Applying it to the income tax is constructive. And sparing SSI recipients from the alternative index is vital. If the alternative price index is applied to Social Security and taxes, but not to SSI, and if such a package is the glue that enables an agreement on measures to resolve the profoundly dangerous ‘fiscal cliff’ uncertainties that Congress now faces, then it is an unsavory pill worth swallowing.