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Obama wants to change key inflation measure: Will it cut Social Security benefits? (FAQ)

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A group of political activists and lawmakers Tuesday presented the White House with a million signatures on a petition opposing a cost-cutting measure expected to be in President Obama's 2013 budget: adopting a new measure to calculate inflation for the purposes of determining Social Security benefits — the so-called  "chained consumer price index," or chained CPI.

The estimated savings would be about $125 billion over 10 years. If the switch were made for calculating tax rates by the Internal Revenue Service, you could add $125 billion in additional revenue to that (because incomes would rise faster than inflation).

But it would affect the benefits increases of millions of Americans — many of whom are in California. The state has more than half a million retirees claiming Social Security.

But you may not even know on what current Social Security benefits and taxes are based when it comes to inflation adjustments. We'll try to unravel it for you.

Q: Why do we use these things in the first place?

A: Because prices almost invariably go up, and benefits are subject to a cost of living adjustment, or COLA. If you're getting $800 a month in Social Security today, that same $800 typically won't keep up with the rate of inflation in the future. So to maintain the purchasing power as costs increase, the Labor Department's Bureau of Labor Statistics publishes an index (among several) — CPI-W — that assesses inflation for all workers in the U.S. and uses it to calibrate COLA in order to have a yardstick for benefit increases.

Q: Sounds good. So what's the problem?

A: According to Darren Rippy, an economist with the U.S. Bureau of Labor Statistics, most economists consider chained CPI to be a more accurate measure of inflation, due to something called "substitution bias." Rippy says the BLS puts together the various indexes in a two-stage process. Stage one takes into account a price increase in a basket of similar goods. If Macintosh apples rise in price relative to Gala apples, consumers will likely buy more Galas and fewer Macintosh apples. The second stage is where things get tricky, because the current CPI-W doesn't address inflation when consumers confront a rise in the price of beef relative to chicken. You literally no longer have an apples-to-apples comparison; rather, it's cows versus fowl. You're substituting one item for another, and they can't be directly compared. 

Critics of chained CPI say there are several tricky substitutions that don't add up. For example, substituting a lower cost generic drug for a name-brand drug. Or, switching from natural gas to heating oil. 

But the upshot is that CPI-W tends to overstate the rate of inflation, according to the BLS.

"If COLA was 2.5 percent using the CPI we do now," Rippy said, "COLA with chained CPI would be 2.2 percent." That would translate into a smaller increase in future benefits.

"Some people view that reduction [in COLA] increase as a cut," said Rippy. "But the benefit is increasing in both scenarios."

Q: That sounds perfectly reasonable. Don't we want a more accurate inflation measure that reflects actual consumer behavior?

A: Sure, but there are politics involved if budget cutting entails trimming future payouts to retirees, even if their current benefits aren't being touched. The American Association of Retired Persons (AARP) is not a fan of chained CPI. 

Brad Wright, a spokesman for the National Committee to Preserve Social Security & Medicare — which presented the petition — said that switching to chained CPI is a "significant cut," not just a technical tweak. "They're hoping people won't notice, but over time it adds up."

"Chained CPI is based on the experience of all urban consumers,"  Rippy said. "But the majority of Social Security recipients are 65 and older, so a better index would be something more accurate for that population."

Q: Great. So let's create that index and use it. Is that a problem?

A. Sort of. As it turns out, the BLS has one of those: CPI-E. But it's an experimental index. The number crunchers in Washington aren't prepared to launch it into orbit yet. But between 1982 and 2011, it shows a higher rate of inflation for seniors than for the overall population (called CPI-U by the BLS), due largely to higher health care costs for the elderly. So we could switch to that, rather than adopting chained CPI, for a specific group of people. 

"They've been playing around with it for years," Wright said. 

"If the agenda is to reduce benefits, then the CPI that's going to accomplish it is chained," said Max Richtman, the CEO of the National Committee to Preserve Social Security & Medicare.

He thinks the debate goes beyond the needs to people 65 and over.

"Everybody hopes they'll eventually reach that age," Richtman said. "And with chained CPI, it gets worse over time. The longer you're on the program, the more ground you'll lose. And the longer you live, the more reliant you'll be on Social Security. You cannot outlive Social Security."

The chained CPI proposal isn't a cut but another way to figure the cost of living for Social Security recipients. 

"What would really occur is a reduction in the rate of growth of COLA over time," says Rippy. 

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