David Lerner Associates: What Is Chained CPI — and Could It Affect You?

David Lerner Associates: What Is Chained CPI — and Could It Affect You?

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2013-09-03

You may have heard or read the term “chained CPI” but aren’t sure exactly what it means — or more importantly, whether it’s something that might affect you. Chained CPI made the news headlines recently when it was revealed that President Obama’s 2014 budget includes a provision that would change the way inflation is measured when calculating annual cost-of-living adjustments (or COLAs) for Social Security.

Currently, Social Security COLAs are determined using the Consumer Price Index (CPI) for Urban Wage Earners and Clerical Workers, which calculates annual adjustments in the prices of items in a basket of common goods and services. Under the President’s budget proposal, chained CPI would be used instead, starting in 2015.

Measuring Inflation Differently

Chained CPI measures inflation differently by considering the fact that people might change their spending habits when faced with rising prices for certain goods and services. Consider grocery prices, for example: If a family typically spends $150 per week on groceries and grocery prices rise 10 percent, this would represent a $15 per week (or $60 per month) increase in their cost of living.

But instead of just absorbing this increase, the family could decide to shop more frugally, clip more coupons, or simply reduce the amount of groceries they buy. In effect, the family has decided to keep its standard of living constant without increasing their cost of living by $15 per week. Chained CPI takes potential changed behavior patterns like this into consideration.

The result is that chained CPI results in a slightly lower rate of inflation than normal CPI. During the 12-year period from the end of 1999 until the end of 2011, chained CPI grew by 2.2 percent, while normal CPI grew by 2.5 percent. Therefore, if chained CPI were used to measure inflation, this would result in about a quarter of a percent lower cost-of-living adjustment for Social Security benefits.

In the short term, this is not a lot of money: It would only be about $3 per month lower on average if chained CPI were implemented in 2014. By 2023, however, the average monthly Social Security benefit would be about $30 per month lower, according to the Congressional Budget Office. By 2033, the CBO projects that overall Social Security payments would be three percent lower using chained CPI.

In effect, the longer an individual receives Social Security benefits, the greater the impact of chained CPI would be. A 62-year-old claiming Social Security retirement benefits, for example, would receive a 0.25 percent smaller payment on average at age 63 if chained CPI were used. At age 73, the payment would be 2.5 percent less on average, and it would be 7.2 percent less on average at age 93.

Why Switch?

So why does the Obama budget propose the switch to chained CPI? It says the switch would reduce deficits by at least $230 billion over the next 10 years and eliminate between 16 and 20 percent of Social Security’s long-term funding shortfall.

It’s important to note that even if the President’s budget is approved, legislation would have to be passed by Congress and signed by the President in order for the switch to chained CPI to take effect.

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA & SIPC.

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Founded in 1976, David Lerner Associates is a privately-held broker/dealer with headquarters in Syosset, New York and branch offices in Westport, CT; Boca Raton, FL; Teaneck and Princeton, NJ; and White Plains, NY. For more information contact David Lerner Associates 1 877 367 5960 http://www.davidlerner.com

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