Measuring Inflation for Social Security

President Obama’s proposal to change the inflation measure used to adjust tax brackets and Social Security benefits is, on the face of it, not an unreasonable tool to coax Republicans to sign on to some grand bargain to tackle the budget deficit.

But a more careful look at the details suggests that the president’s proposal may not be the most effective way either to raise money or to reform the nation’s pension system.

The “chained Consumer Price Index” that the White House proposes to use is, after all, a more accurate measure of the inflation experienced by American families than the index used today, taking into account that consumers respond to the rise in the price of one good by shifting to cheaper alternatives.

Because it rises more slowly than the current index, the White House estimates that the move would cut the budget deficit by $230 billion over the next 10 years.

The slower rise of the chained index would slow cost-of-living adjustments of Social Security benefits and some other programs, saving $130 billion over a decade. And it would raise $100 billion in tax revenue by slowing the rise of tax brackets - which are also adjusted for inflation- keeping more taxpayers in higher brackets paying higher marginal rates.

Notably, it is meant to show Republicans that the president’s commitment to entitlement reform is for real.

But despite these selling points, the White House’s proposal also exemplifies the pitfalls of tweaking government programs while paying perhaps insufficient attention to what the programs are meant to achieve.

The chained C.P.I. may be a better index to measure prices across the population, but not necessarily for the old - who spend a larger share of their income on health and housing. Economists at the Labor Department have been experimenting for years with a special price index for those over the age of 62. Since 1982 it has risen 0.2 percentage points per year faster than the standard C.P.I. The chained C.P.I., by contrast, has lagged behind the regular index over the longer term by about 0.3 percentage points a year.

Swapping inflation indexes as the White House proposes might also introduce perverse incentives into the system. Experts like Eugene Steuerle at the Urban Institute argue that Social Security must encourage workers to stay longer in the labor force, helping the economy over the long term and reducing the tax burden on younger Americans devoted to supporting the old. That might be done reducing the benefit for early retirees.

The proposal does try to alleviate the effect on poorer beneficiaries, offering increases beyond the chained index from age 76 to age 85. But by age 75, the monthly benefit for someone who retired at 65 would still be almost 4 percent less when using chained C.P.I. than when using the conventional index. And it would be about 4.5 percent less at age 95.

Paul Van de Water of the Center on Budget and Policy Priorities, a liberal-leaning research group, supports the White House’s overall proposal. Still, he is uncomfortable with the changes. “Even if you wanted to cut Social Security benefits, this is not the right way to do it,” he said. “You would want benefits to go up as people get older because their other sources of income are depleted.”

And it’s not a great tax proposal, either. Most tax experts in and out of government seem to agree that the most effective way to raise revenue is to broaden the base of taxpayers, rather than to raise marginal tax rates. But slowing the adjustment of tax brackets would effectively raise the rates paid over time by taxpayers across the board.