How the Chained CPI Affects Social Security Payments

Retirees are likely to get smaller monthly payments using this new measure of inflation.

Retirees are likely to get smaller monthly payments using this new measure of inflation
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In his 2014 budget, President Obama proposes changing the measure of inflation used to calculate annual Social Security cost-of-living adjustments from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI) to the chained CPI beginning in 2015. This change would modestly improve the Social Security system's finances, but result in retirees getting slightly smaller annual increases in their Social Security checks. Here's a look at how your Social Security payments will change if the chained CPI is used to calculate future Social Security payment increases:

[Read: How Obama's Budget Impacts Retirement Savers.]

Lower benefits over time. The chained CPI has grown more slowly than the traditional CPI by an average of about 0.25 percentage points over the past decade. If the chained CPI were implemented, Social Security benefits would be about $3 per month lower in 2014, and about $30 a month lower by 2023, according to Congressional Budget Office calculations. And by 2033, Social Security payments are projected to be 3 percent lower than they would be using the current measure of inflation. "For Social Security, that policy change would not alter the size of people's benefits when they are first eligible, either now or in the future, but it would reduce their benefits in subsequent years because of the reduction in the average cost-of-living adjustment," says Jeffrey Kling, associate director for economic analysis at the Congressional Budget Office. "The impact would be greater the longer people received benefits, that is, the more reduced cost-of-living adjustments they experienced."

Compounding cuts. The impact of the slower-growing measure of inflation would increase over time. For example, a worker who claimed retirement benefits at age 62 would, on average, get a 0.25 percent smaller payment at age 63 if the chained CPI were used instead of the current measure of inflation. After 10 years of Social Security payments and cost-of-living adjustments, this 73-year-old retiree would get 2.5 percent less, on average, than under current law. And at 93, this person would get an average of 7.2 percent less in Social Security payments over his or her lifetime. "Where the index was used to inflate a benefit or payment level, such as with Social Security, all program participants would receive a lower benefit than they would under current law," says Kling. "The impact would be especially large for some disabled beneficiaries; they generally become eligible for Social Security benefits before age 62 and thus can receive cost-of-living adjustments for a longer period."

[Read: 10 Things Everyone Should Know About Social Security.]

Rationale for the switch. The CPI estimates the annual change in the cost of living by calculating the adjustment in prices consumers pay for a basket of goods and services in urban areas of the U.S. The chained CPI measures inflation differently in a way that takes into account the idea that people might change their spending patterns when prices for specific items rise. "The chained CPI-U represents the latest stage in the development of our cost-of-living measures and improves on the CPI-U by accounting for how consumers substitute among goods when the price changes of those goods vary," says Erica Groshen, commissioner of the Bureau of Labor Statistics (BLS). For example, a worker who typically spends $80 per week on gasoline and experiences a 10 percent increase in gas prices has seen their current cost-of-living increase by $8 per week. But that consumer could also decide to cut back on driving and ride the bus occasionally. "The consumer would be deciding if she would be better off by shifting her spending pattern than by spending the entire $8 on gasoline," says Groshen. "Put another way, the cost of keeping her standard of living constant has gone up by something less than $8 per week." Due largely to this substitution affect, "this formula generally shows a lower rate of inflation," says Groshen. Between December 1999 and December 2011, the CPI grew at an average annual rate of 2.5 percent, compared with 2.2 percent for the chained CPI.