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Adjusting the Consumer Price Index.

The Consumer price index (CPI) is our national inflation gauge. It is supposed to represent the impact of changes in prices over a period of time. It is used to adjust benefits, such as Social Security, and taxes. It also is wrong!

Every month, the Bureau of Labor Statistics sends out about 400 data collectors to record roughly 80,000 prices of everything from meat to college tuition. Cemetery lots, tax preparation fees, and about 100 new car models regularly are priced. The idea is to replicate a "market basket" of goods and services purchased by typical American consumers. Individual prices are weighted in the index according to their importance in people's buying habits.

Unfortunately for accuracy's sake, this market basket is updated just once a decade, based upon a huge survey of people's spending. However, buying patterns change constantly. Ten years ago, relatively few had video cassette recorders (VCRs) or personal computers. Today, millions have both. As the cost of renting video cassettes decreases and the cost of going to the movies increases, people will rent more. Because the CPI is revised only periodically, these changes will be understated, and the index itself will be in error.

New products clearly skew the index. I bought one of the original electronic pocket calculators in 1970 for $400. Today, I can get a smaller model that does twice as much for less than $10. Microwave ovens were first included in the index in 1978; VCRs and personal computers did not show up until 1987. Moreover, improvements in quality are ignored. Current models of refrigerators use less electricity and new drugs replace surgery. The index misses both changes.

Recently, a panel of five prominent economists, chaired by Michael Boskin of Stanford University, concluded that inflation, as measured by the CPI, is overstated by a full percentage point, or even two. The implications of such an overstatement are enormous.

The CPI is used to adjust government benefits (mainly Social Security) and taxes-specifically, the personal exemption, standard deduction, and tax brackets. For instance, the government has announced that Social Security benefits for 1996 will rise 2.6% because the CPI increased by 2.6% over the last year. The above tax adjustments also will be modified by 2.6% (appropriately rounded) so that inflation will not erode benefits or increase taxes. An overstatement of the index can be devastating to the budget; a correction to the index can be potentially lifesaving to the deficit.

For example, according to the Congressional Budget Office, the impact of a one percent point downward adjustment in the CPI over the next seven years would see tax revenues increase by $98,000,000,000; Social Security save $101,600,000,000; other spending drop $43,200,000,000; and debt service decrease $38,600,000,000. The net result would be a $281,400,000,000 reduction in the national deficit!

In the current political environment, neither Congress nor the White House have the suicidal tendencies or the courage necessary to ask directly that nearly every taxpayer shell out more in income tax each year or to cut the average Social Security benefit by $7 each month. Yet, "correcting" the CPI for inflation by one percentage point would have the same result.

After reviewing the Boskin Report, Sen. Daniel Patrick Moynihan (D.-N.Y.) declared on the op-ed page of The Washington Post: "If we were to do no more than declare that henceforth the cost of living adjustment will be the CPI minus one percentage point, we would save $634 billion over the next ten years."

The Bureau of Labor Statistics, which uncovered many of the problems with the Consumer Price Index, still is considering the Boskin Report. The Bureau is unlikely to recommend changing the official index so that reported inflation would fall by a full percentage point. Nevertheless, even a one-half percentage point change would matter. One-quarter of all union contracts use the Consumer Price Index to adjust wages, as do many non-union employers.

If there has been an overstatement of true inflation, that means recent trends in wages, economic growth, and productivity really are better than past statistics have suggested. Moreover, it implies that the Federal Reserve has been much more successful in cutting inflation and creating price stability than previously thought. The economic picture is a lot brighter with an inflation rate below two percent than it appears under the current official rate of nearly three percent.

Moreover, if the demon inflation truly has been tamed, the Federal Reserve more easily could stimulate the economy with an interest rate cut. Such a reduction would save substantial dollars for consumers living on credit card debt, awaken the housing market, and potentially bring buyers back into the auto showrooms. More housing means more wood being used, more appliances being purchased, and more people working. More car bought means more steel being used, more radios needed, and again, more people working.

If inflation really is down, the Federal government can reduce spending, increase tax collections through smaller adjustments and stimulate the economy. The latter would add more jobs and further increase tax collections. The leveraged results on the budget and deficit would be enormous in the positive direction. The thought brings a smile to my face; the fact would bring a bulge to my pocket.
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Author:Schnepper, Jeff A.
Publication:USA Today (Magazine)
Date:Jan 1, 1996
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