What Is ‘Chained CPI’? How The New Proposal Will Affect Social Security And Taxes

The Obama administration included in its 2014 budget proposal, which was submitted to Congress Wednesday, “chained CPI,” a recalculation of the Consumer Price Index that will change how the government calculates the annual cost-of-living adjustments for millions of Social Security and other benefit recipients as well as the annual inflation adjustments to the federal tax code.

This means that your income taxes will be higher and your Social Security benefits will be lower, a prospect that has both liberals and conservatives displeased.

Chained CPI, as opposed to the current way the Consumer Price Index is measured, takes into account when people replace expensive goods with cheaper ones, resulting in a lower annual inflation rate.

When you pay income taxes, the tax bracket you fall under is determined by how much taxable income you have and over time, due to inflation, the cutoffs for each bracket rise.

So with chained CPI, those cutoffs will rise slower, which means you lose your money quicker, getting exposed to higher tax rates compared with now.

With regard to Social Security benefits, the slower inflation rate has the same effect. While you pay more, the benefits you receive from Social Security, in turn, grow more slowly as well. When you collect your Social Security checks, the amount will be smaller than it would have been otherwise.

Peter Orszag, a Citigroup executive who formerly worked as an Obama budget director, estimates that the government will save around $150 billion in the next decade if Congress adopts the new measuring index.

“This does not amount to bold long-term deficit reduction. On the other hand, it wouldn’t be the end of Social Security as we know it either,” Orszag wrote in a Bloomberg View column.

Analysts predict that the gap between the current CPI measure and the new chained CPI proposal will spread out over time to 25 to 30 percentage points, meaning chained CPI will, in the end, save more money than what’s expected.

Click here to view a graph on a change of consumer price indexes.