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In an attempt to reduce the federal deficit, Congress and the Administration are considering changing the consumer price index — a change that would have a particularly negative impact on Social Security benefits

Their proposed change, the “chained CPI,” is estimated to lower the CPI by 0.3 percentage points each year, taking approximately $112 billion out of the pockets of current and near retirees in the next 10 years alone.  A typical beneficiary – with an annual income of roughly $20,000 — will lose over $2000 dollars of benefits over 10 years. Find out how much you would lose.

The primary argument for chained CPI is that it is a more accurate measure of inflation — but in fact, the evidence suggests it’s even less accurate than the current formula.That’s because the chained CPI is based on a notion of substitution of lower cost goods by consumers when the prices of certain goods rise (e.g., when the price of beef rises, people buy more chicken).  However, there is no evidence to suggest that the substitution effect reflects the spending habits of seniors. That’s because most seniors have modest incomes and have less opportunity for substitution because they are already choosing lower priced goods, and many costs for seniors (e.g., health care, utilities) do not have lower price alternatives.

In addition, the current measure for Social Security – the CPI-W formula – is based on the spending patterns of workers, not retirees.  As a result, the current CPI under-reports the rapidly increasing health care costs experienced by seniors. The CPI-E, an experimental index that re-weights the index to reflect senior’ spending habits, shows that the CPI-W on average under-reports inflation by 0.2 percentage points each year.  As such, the evidence suggests the current COLA is already lower-than-warranted for seniors.

The adoption of the chained CPI is likely to further erode seniors’ standard of living. A chained CPI makes sense only in a budget deficit driven world, where accuracy takes a back seat to benefit cuts for the purposes of deficit reduction.