Right data.

THE good news: we're better off than we think we are. The bad news: it'll cost us.

Michael Boskin's panel says the Consumer Price Index overstates the true rise in living costs by 1.1 percentage points per year. The budgetary implications are huge. About 30 per cent of federal outlays, including most entitlements, are indexed to inflation, as are income-tax brackets. Cutting the cost-of-living adjustment by 1.1 percentage points would cost the typical Social Security recipient about $100 next year in reduced payments. Taxes for a family earning $50,000 would go up by about the same amount. And over time, the amounts compound. If inflation (as measured by the current CPI) stays at 2.8 per cent, average retirement benefits in 2006 would be $1,280, or 10 per cent, below the amount forecast under current law.

Economists have long suspected an upward bias in the government's inflation numbers. There are three major reasons. Most obviously, the "market basket" is seldom changed, ignoring consumers' ability to seek out cheaper items. If the price of hardcover books goes up, more readers will buy paperbacks or go to the library. The negligent CPI would go up even though the consumer's cost of living actually declined. Another type of substitution -- the widespread switch to discount outlets -- is also ignored. The CPI tracks only "list prices."

The official inflation rate also misses price declines that typically occur after new products are introduced. VCRs and microwave ovens first appeared in the CPI formula a decade after they were in widespread use -- when their prices had fallen more than 80 per cent. Personal computers didn't enter the mix until roughly 12 years after the appearance of the first home PC. Until 1940, the CPI reflected the price of trolley cars but not automobiles. (The current index is based on what people bought in 1982 - 84.)

Last, but hardly least, there is the failure to adjust for quality improvements. The CPI, for example, does a good job of tracking rent per square foot but ignores amenities in apartment buildings such as swimming pools, health clubs, and modern appliances. If an appendectomy required four days of hospitalization ten years ago, but only one day now, tracking simply the per-diem cost represents a serious distortion.

To a large extent the administrators of Washington's statistical apparatus acknowledge the gaps and distortions. The Bureau of Labor Statistics is well along in developing a mechanism to correct the substitution and new-product problems. But quality improvements, which Boskin says account for more than half (0.6 percentage point) of the total CPI overstatement, are far more difficult to rectify. As a practical matter, that overstatement can be fixed only if Congress rewrites the law to adjust benefits and tax brackets by the CPI minus 0.6 percentage point. Alan Greenspan suggested a similar expedient for Social Security back in 1983.

Beyond the budgetary effects, a new CPI would rewrite recent economic history. The conventional wisdom holds that real income for the average American worker peaked in 1973; Boskin's data show a 13 per cent rise in hourly earnings since then -- most of the improvement occurring between 1981 and 1989.

DEFLATING THE DEFICIT

        Do       Clinton    Clinton Plan Plus
      Nothing     Plan      1.1% COLA Reduction

1997  $169 bil.  $149 bil.   $141 bil.
1998   177        152         135
1999   184        123          93
2000   193        106          63
2001   196         56           2
2002   150    - 1 (Surplus) - 71 (Surplus)
Source: CBO