Over at the Washington Post, Ezra Klein argues that a change in the Consumer Price Index (CPI) could make for better policy and better politics in helping address the budget deficit. Klein isn’t alone in his view, and I’ll admit that my dissent is a minority, but I think I’ve got a good point.
The CPI is used to adjust Social Security and other federal benefits, as well as to increase the dollar values assigned to income tax brackets. Klein and others propose shifting federal policy from the conventional CPI to the so-called chain weighted CPI, which better measures how consumers shift between competing products as prices change.
I have no disagreement that, in general, the chain weighted CPI is a superior measure of inflation to the standard CPI-W used to calculate COLAs or the CPI-U used to index the income tax brackets. However, the chained CPI is the wrong measure for Social Security benefits and the income tax code. A better measure for Social Security would be a chain weighted version of the CPI-E, which measures price changes for individuals over 65. This probably would still show lower inflation than the current CPI, by around 0.1 percentage point annually, but would be superior to the current CPI-W, the chained CPI, or the CPI-E on its own (which tends to show higher inflation).
The chained CPI is also inappropriate for use in the tax code. By lowering adjustments to the tax brackets, over time it would make more of individuals’ earnings subject to higher tax rates, an effect known as “bracket creep.” Even using the current CPI, and assuming that the Bush tax cuts were made permanent, average tax rates and tax revenues relative to the economy would soon rise to record levels, according to the Congressional Budget Office (CBO). Applying the chained CPI to the tax code would only speed up this effect. A more appropriate way to index the tax brackets is by the growth of incomes or wages. This would keep average tax rates, and taxes relative to GDP, stable over time. If people wish to raise taxes, that’s fine, but it should be done overtly rather than through stealth. Having an in-built bias toward ever-higher taxes isn’t good policy.