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Expert: New inflation index could reduce budget deficit

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With its Nov. 23 deadline looming, the Congressional “super-committee” charged with reducing the federal budget deficit may change how the government measures inflation, which could raise tax revenues and lower government expenses like Social Security, says law professor Richard L. Kaplan.

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11/21/2011 | Phil Ciciora, Business & Law Editor | 217-333-0568; pciciora@illinois.edu

CHAMPAIGN, Ill. – With its Nov. 23 deadline looming, the congressional “super-committee” charged with reducing the federal budget deficit may change how the government measures inflation, which could raise tax revenues and lower government expenses such as Social Security, a University of Illinois expert on taxation and retirement issues says.

Although switching to a different consumer price index would slow the growth of the federal deficit, it’s not a complete answer to our fiscal problems, says law professor Richard L. Kaplan.

“It’s not a silver bullet, but it could receive bipartisan support as a step toward reducing the government’s ever-widening deficit,” said Kaplan, the Peer and Sarah Pedersen Professor of Law.

According to Kaplan, switching the consumer price index to the so-called “chained” consumer price index assumes greater consumer response to price increases.

“The current CPI assumes that if the price of McIntosh apples goes up, some consumers will buy less expensive Golden Delicious apples instead,” he said. “But the ‘chained’ CPI assumes that these consumers will buy a different type of fruit entirely, such as oranges or bananas, thereby lowering their cost of food.”

If inflation were measured as lower than under the existing index, certain key components of the federal income tax would not increase as much, Kaplan says.

“For example, the starting amounts for the tax brackets are indexed for inflation, as are the personal exemption and the standard deduction,” he said. “If these amounts rise more slowly, the income tax will bring in more revenue than current law provides.”

Similarly, various government benefits that are tied to inflation would increase more slowly.

“Annual cost-of-living-adjustments for Social Security payments are based on the CPI, so lower inflation translates into smaller benefit checks,” Kaplan said. “From the government’s perspective, it’s a win-win: more income coming in and less expense going out.”

According to Kaplan, changing the measure of inflation could be controversial.

“The purpose of inflation adjustments is to accurately determine the extent of inflation that people confront, and there is no empirical evidence that real-life consumers respond to price increases in the manner that the ‘chained’ CPI assumes,” Kaplan said. “If they do not make the sort of product substitutions that the new inflation measure assumes, the ‘chained’ CPI will not be an accurate reflection of inflation.”

Furthermore, certain consumers face different levels of inflation even under current practices.

“Older Americans, for example, typically spend a much higher proportion of their budgets on health care expenses than the current CPI includes,” he said. “Consequently, the current CPI understates the level of inflation that most Social Security recipients experience.”

For that reason, the Bureau of Labor Statistics compiles the CPI-Elderly, which includes a larger component for medical outlays, Kaplan says.

“That is a critical feature, because health care costs generally rise faster than other goods and services,” he said.

But applying the CPI-Elderly to Social Security benefits would probably increase government expenditures – “and that is not a path that most policymakers want to pursue right now,” Kaplan said.

Editor's note: To contact Richard Kaplan, call 217-333-2499; email rkaplan@illinois.edu.

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