The Chained CPI - How Big Of A Difference Does It Make?

by: Arthur Stein

A proposal in President Obama's 2014 budget request reduces cost-of-living adjustments (COLAs) for Social Security benefits, federal pensions (annuities) and other benefits by calculating inflation with the "Chained Consumer Price Index," (C-CPI-U) instead of the traditional inflation index (CPI-W).

In addition, the proposal increases tax revenue by switching to the Chained CPI - instead of the current CPI - to adjust income tax brackets, the standard deduction, the personal exemption and other parts of the tax code.

The Chained Consumer Price Index differs from the current indexes because it takes into account - on a monthly basis - changes in consumer purchases as the costs of some items increase or decrease more than others do. For instance, if apple prices increase, some people purchase fewer apples or purchase other fruit that didn't increase as much.

The Bureau of Labor Statistics (BLS) calculates the indexes and uses the same survey data for all.

From December 1999 to December 2012, the Chained CPI was .28% per year less than CPI-W.

While a Chained CPI may provide a more accurate indication of inflation, it seems clear the reason for the switch is to reduce the federal budget deficit. Lower COLAs reduce annual increases in Social Security payments and federal pensions. Tax revenue increases because tax brackets, deductions and exemptions do not rise as quickly.

For the Federal Government, that means a lower budget deficit. For retirees, that means a reduction in future income. Those reductions compound over time, becoming larger in later years.

The table below details the difference in yearly payments and total payments for retirements of different lengths.

Annual Payments Total Payments
Estimated percentage difference in each year's annuity payments between chained CPI and regular CPI inflation adjustments Estimated percentage difference in total (cumulative) lifetime payments between chained CPI and regular CPI inflation adjustments
Retirement year That year's payment would be reduced this amount with chained CPI You live this many years in retirement You receives this much less from chained CPI
10 -2.4% 10 -1.3%
15 -3.7% 15 -2.0%
20 -5.0% 20 -2.8%
25 -6.3% 25 -3.5%
30 -7.6% 30 -4.3%
Note: From December 1999 to December 2012, chained CPI averaged 2.17% and CPI-W averaged 2.45%. Assumption: Same future difference in inflation rates between chained and regular as there were from December 1999 to January 2013. Data: Bureau of Labor Statistics. Calculations by Arthur Stein, CFP®.

The Bureau of Labor Statistics also calculates an experimental "CPI for the elderly" index, called CPI-E. It takes into account the different expenditure patterns for older Americans. The BLS definition of elderly is 62 and older (I personally hate that definition).

From 1982 through 2011, expenses for the elderly were .2% per year higher than the overall inflation rate.

The inflation index for the elderly was higher for several reasons. The elderly spent substantially more on medical care and medical care inflation is much higher than the overall inflation rate. Another reason is housing costs, which increased more rapidly than overall inflation over the same time period.

So Social Security and federal pension payments have been losing purchasing power for a long time. The change to the Chained CPI will only make that worse.

Switching to the Chained CPI will affect the less wealthy more than the wealthy.

  • Retirees solely dependent upon Social Security, federal pensions and other indexed income must compensate by reducing expenditures. For a poorer person, that can mean reducing purchases of food, clothing, medical care, etc.
  • Retirees with significant amounts of investments can compensate with investment income.
  • Retirees who live a long time will suffer more than those who die early.

Finally, everyone will pay slightly more in income taxes.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.