The Reason Chained CPI Hits Seniors So Hard Is The Same Reason It’s So Good At Deficit Reduction

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One of the key elements in President Barack Obama’s budget is the proposal to adopt the “chained CPI,” a metric that will make Security Security inflation adjustments increase at a slower rate.

The move is a concession to factions in the GOP that want to see some form of entitlement reform before coming to the table for a budget negotiation. 

Still, the move has alienated the president from former allies, campaign supporters and progressives on the left. The decision to shift to chained CPI is, unquestionably, a major cut to benefits.

On the same token, slowing the rate of cost of living adjustments is definitely a way to reduce the deficit. 

According to the Congressional Budget Office, on average the rate of chained CPI growth is 0.25% less than the rate of CPI growth. While this might not seem like much, the way CPI is used to calculate the annual cost of living adjustment is compounded annually. 

For instance, if the annual growth rate of the current CPI metric — CPI-W — is 3 per cent, then the average annual growth rate of chained CPI would be 2.75 per cent.

Over time, the compounding effect of annual cost of living adjustment increases will show a major difference between what a person earns under CPI and what a person earns under chained CPI. 

As simplified example of this compounding effect, compare the Social Security payouts for a single individual who elects to receive payments at 65 at $10,000 per year initially.

The blue line is the total annual payment with CPI — an example inflation rate of 3% — and the red line is the total annual payment with chained CPI — at the example inflation rate of 2.75%. 

social security comparison

You’ll notice that — as intended — the annual payments grow more slowly with our sample chained CPI than they do under CPI. The thing is, that really adds up over time. 

Here’s the chart of the cumulative losses for the individual in this hypothetical scenario:

Walter Hickey/BIIn short, a shift to chained CPI means increasing, compounding losses over time for Social Security beneficiaries. 

Still, consider this from the government’s perspective. Under the White House plan, here’s how much the government saves annually through the move to chained CPI, for mandatory spending alone:

social security cuts

Each year, the government benefits more and more from the change to COLA. 

This is why, despite the benefits it strips from seniors on Social Security, the cost of living adjustment change is so enticing for policy makers.

Targeting cost of living adjustments is a way to cut benefits without looking like they’re cutting benefits, while at the same time cutting benefits in such a way that the cuts compound and grow. 

The compounding effect — the part of the plan that makes this so difficult for beneficiaries — is the exact reason Washington policymakers love the idea as a form of deficit reduction.