How should the government measure inflation?

Changing the way government adjusts spending and taxes for inflation is one of those issues that continues to hang around the edges of the budget debate. Republicans and many economists argue for shifting to a more accurate inflation measure, called the chained Consumer Price Index (CPI). President Obama would support a version as part of a fiscal grand bargain. Because Social Security benefits would likely grow more slowly under this measure, many Democrats and social insurance advocates strongly oppose the idea.

But a new Congressional Budget Office estimate shows fiscal effects that chained CPI backers might not want to see. It turns out that shifting to the new inflation measure would raise taxes by nearly as much as it would slow Social Security spending over the next decade. Indeed, after 2021, the adjustment would raise taxes more than it would cut projected Social Security benefits.

CBO figures chained CPI would raise taxes by nearly $124 billion over 10 years. It would reduce projected Social Security spending by $127 billion and cut planned spending for all programs by a total of $216 billion. Note that CBO counts a nearly $18 billion cut in refundable tax credits as a spending reduction. If you prefer to include it among the tax hikes, the overall revenue increase would reach $142 billion over 10 years.

Back in 2011, the Tax Policy Center figured the shift would raise taxes by an average of about $140 per household. Most households within a vast income range (from $20,000 to $200,000) would see their after-tax income fall by about 0.2 percent on average. Those making more would see their incomes drop by about half as much.   

A quick word on what’s happening here: Chained CPI is an effort to measure consumer responses to changes in prices. If, for instance, the price of a brand-name drug goes up, consumers may respond by buying the generic version, thus softening the blow of the price hike and slightly lowering inflation.

Because spending programs are adjusted for changes in cost-of-living, the more modest CPI growth would trim benefit increases each year. Advocates for the Social Security status quo argue these small annual changes would add up over many years and the biggest victims would be the very old and the very poor.

But the tax increases are just as big, though rarely discussed. The government also adjusts tax brackets and other elements of the income tax for inflation in an attempt to reduce a phenomenon known as bracket creep. The problem: Rising incomes can bump people into a higher tax bracket. 

Three decades ago, Ronald Reagan convinced Congress to stop most of this by indexing the income tax by the CPI. Shifting to a less generous measure of inflation would restore a bit more bracket creep to the code and raise taxes for about three-quarters of all households, TPC figures.

If the proposal shows up in the next House GOP budget, expect to hear many Democrats object loudly to what they see as the basic unfairness of the plan. But neither Republicans nor many Democrats will say that moving to chained CPI also crosses both the GOP’s no-new-taxes pledge and Obama’s vow to protect individuals making $200,000 or less from tax hikes. I wonder if anyone’s told Grover Norquist?