President Obama’s 2014 budget proposal calls for a reduction in future Social Security outlays by changing the annual cost-of-living increase to a method called chained CPI. The change is estimated to reduce the federal budget deficit by $340 billion over the next 10 years.
Social Security benefits are currently adjusted annually by the Consumer Price Index (CPI). In 1996, the Boskin Commission studied CPI and determined it over-estimated inflation by 1.1 percent. CPI is used to calculate cost-of-living adjustments for various government programs and to index portions of the tax code to ensure that these programs and tax provisions keep pace with inflation. Using a more accurate measure of inflation than CPI would help achieve this goal and save outlays from spending, while curbing loss revenue from tax provision changes. Overcompensating recipients for the true cost of living increases may actually be contributing to inflation.
Chained CPI was created by the Federal Bureau of Labor Statistics. It assumes consumers change their buying habits when goods and services become more expensive. If a consumer spends $20 per month on tomatoes and the price of tomatoes suddenly increases, it is unlikely that their cost of living will go up by $20. Instead, the consumer is likely to buy another vegetable which is less expensive. This is known as substitution bias and is not accounted for in the current calculation of CPI.
Chained CPI is considered a more accurate measure of inflation because it better takes into account consumer behavior. Estimates indicate using chained CPI since 2000 would have lowered benefit increases by between 0.25% and 0.3% annually. The new methodology will not reduce current Social Security benefits. It slows the annual increase over time.