May 26, 2011

GETTING THE DEBT under control will require some difficult choices, but not every step must be painful. There is a relatively easy way to save about $300 billion over the next decade — by adopting a more accurate method of calculating increases in the cost of living. Even in an era of trillion-dollar deficits, that is real money — and the savings would be even greater in later years. This change, which has been endorsed by groups across the ideological spectrum, ought to be taken up in the debt reduction discussions being chaired by Vice President Biden.

Much of the federal government’s spending and revenue collection is on autopilot. Benefits for programs such as Social Security and civilian and military pensions, and eligibility levels for other programs, are indexed to inflation. As the cost of living rises, benefit checks grow, too. Tax brackets and other features of the tax code are similarly indexed. So as prices rise, so does the size of the standard deduction or the level at which a particular income tax bracket applies. Indexing makes sense, but the measurement is inaccurate. It overstates inflation because the market basket of goods that is used to measure increases in the cost of living does not allow for what economists call upper-level substitution bias. For example, imagine that apples are part of the basket. If the price of apples doubles, it’s likely that consumers will purchase fewer apples and more, say, pears. But the traditional calculation of the consumer price index assumes that consumers will buy the same basket of goods every month no matter what the price.

An alternative measure, known as the Chained CPI, adjusts for change in consumer behavior and provides a more accurate inflation measure. The difference is small — a fraction of a percentage point annually — but the effect compounds over time.

Among the organizations that have endorsed a switch to the Chained CPI are the president’s fiscal responsibility commission (better known as Simpson-Bowles), the Bipartisan Policy Center’s Deficit Reduction Task Force, the conservative Heritage Foundation and the liberal Center for American Progress. Over the decade, switching to the Chained CPI would save $112 billion in Social Security alone, $33 billion in other federal retirement programs and $23 billion from other programs with eligibility or benefit levels pegged to the cost of living, according to a new paper from the Moment of Truth Project, the successor to Simpson-Bowles. Meanwhile, it could raise another $87 billion in tax revenue over the period. Including interest savings, the change adds up to at least $300 billion.

As obvious as this step appears, it could encounter resistance on the left and right. For the left, the change could be problematic because it would mean benefits would be lower than they would be under the existing path. For the right, the change could be construed as a tax increase. Both these responses would be misguided. A more accurate inflation measure that saves money ought to be a no-brainer.