The Social Security proposal you need to know about

Lawmakers have suggested a switch to 'chained CPI' to reduce deficits. That could affect how the government calculates Social Security benefits in the future.

By Bruce Kennedy Dec 20, 2012 9:21AM

It sounds about as exciting as skim milk, but the phrase "chained CPI" could play a role in fiscal cliff negotiations -- and it could impact your Social Security payments.

Republicans are reportedly suggesting a shift to chained CPI as one way of dealing with the deficit, and President Obama appears open to the move. That could impact the way Social Security benefits are calculated in the future.

To understand chained CPI, it's important to get a refresher on the standard CPI, or the Consumer Price Index. This index tracks price changes of goods and services in some 200 categories. The Bureau of Labor Statistics defines the index as "a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services."

The government uses the CPI as one basis for adjusting dollar values on Social Security payments. During times of inflation, for example, the index rises and Social Security payments get cost-of-living adjustments, or COLAs.

"Chained CPI" doesn't just look at the prices of goods and services. It goes deeper into consumer choices and relative price changes. For an example, says the BLS, consider differences in the costs of pork and beef.

If the price of pork goes up while the price of beef doesn't, shoppers might shift away from pork to beef, the Bureau notes. Chained CPI accounts for this type of consumer substitution, while the standard CPI does not.

And here's the important part: In this example, chained CPI would rise, but not by as much as the standard CPI. In fact, the Congressional Budget Office says the chained CPI has grown at a slower rate than the traditional CPI, by an average of 0.3 percentage points annually over the past 10 years.

So what does that mean to you, the taxpaying consumer? Switching to a chained CPI will reduce spending on Social Security and federal pensions while increasing revenue for the government. The differences between the CPI and chained CPI may seem small, but they can add up. As the Columbia Journalism Review points out, the chained CPI "cuts spending and raises revenue, the twin strategies for reducing the federal deficit."

There are estimates the chained CPI could bring in hundreds of billions of dollars in savings for the government while generating billions more in revenue. The unanswered question, though, is at what cost.

In a recent letter to Congress, the National Committee to Preserve Social Security and Medicare urged lawmakers to oppose any deficit reductions plans that would involve the chained CPI.

"This cut would reduce projected benefits for the oldest and most vulnerable Americans who would be least able to afford it," says the letter, which also notes that Social Security Administration officials estimate the chained CPI would bring about a 0.3 percentage drop compared to current cost-of-living adjustments.

"This reduced COLA would result in a decrease of about $130 per year (0.9%) in Social Security benefits for a typical 65 year old," The letter continues. "By the time that senior reaches age 95, the annual benefit cut will be almost $1,400, a 9.2% reduction from currently scheduled benefits. Remarkably, this is a benefit reduction that slightly exceeds the one month’s benefit for the average retiree."

The Christian Science Monitor says supporters of the chained CPI believe it’s a better way to measure inflation and reduce the deficit -- especially as a growing number of Baby Boomers retire and go on Social Security.

But there's also a middle ground in the debate, according to the Monitor: those who argue that the change "should be cushioned by supplementing benefits for older retirees."

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