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I like to read and write about economics and finance but hesitate to do so because (1) it's hard to explain anything without explaining everything, and the draft diaries just get too long until I have to abandon them, (2) a lot of DKers have a lot invested in certain views about economics and finance that are not really open to empirical (ie factual) analysis, but instead are based on political commitments and emotion, and (3) despite how crazy the Republican Party is, once in a while Democrats, Republicans, technocrats and policy wonks actually agree on something, and even if the most credible progressive policy wonk institute says a particular assertion is true, if a Republican also says it's true, and someone on DK finds a link to said Republican saying such rare sane assertion, it becomes automatically discredited.

But today's hysteria over the "cuts" to Social Security on the proverbial political table and the even wilder assertion that the Obama administration is committing political suicide by discussing them, let along enacting them, has persuaded me to provide a dollars and sense (as well as economic theory) explanation of what's going on.

If you don't like economics, public finance or numbers, then let me not bury the lede and explain exactly what's on the table.  If enacted, the average social security recipient would get 14 cents less of an increase per month, but only in a month in which the social security benefit actually went up by about $34.  So the assertion being made in several diaries is that social security recipients will revolt because their average monthly benefit went up from $1,044 to $1,078.31 instead of $1,078.45.  Of course someone would have to point out some highly technical macro economic measuring theory first, and then get them riled about about that monthly dime at a time when they are actually getting a net of more money.  So yes, it does look like 11 dimension chess (offering the Republicans nothing of substance).

The so called "cuts" being discussed are not cuts in actual benefits, but cuts in how increases are to be measured based on the consumer price index.  

The consumer price index is a measure of inflation, that is, the decline in the value of the dollar which is an almost constant in economic history (except during periods of deflation).  Because the value of the dollar goes down, people on fixed incomes see the amount they can purchase with the same dollars go down.

To prevent people on social security from suffering a declining standard of living, the social security administration uses a measure of inflation to increase the cash amount distributed to each social security beneficiary.  The idea is that we want seniors who depend on social security to be able to buy the same amount of goods and services regardless of what the value of the dollar is.  The amount by which social security payments go up each year with inflation is called the "cost of living adjustment" or cola for short.

The consumer price index is a basket of goods and services that the average urban consumer buys.  The federal government makes it a lot more complicated than that because they have tried over the years to make it accurate.  So it reflects many different baskets of goods and services in many different urban locations.  There are several different consumer price indexes to measure the effect of inflation on different segments of society.

Since the mid 1990s, economists have worried that the consumer price index generally used by the federal government slightly over estimates inflation.  

Because so many revenue and spending issues depend on the consumer price index, this means that benefits and burdens of tax payers and benefits recipients are generally not being accurately measured.

Everyone knew that the CPI was wrong, but we continued to use it for many reasons.  For example the federal government knew that many, many businesses use the CPI for contracts between each other, and changing the CPI would basically affect tens of thousands of private transactions.  The CPI, as some economists noted, is one of the many economic number the government continued to publish even though they knew it was wrong.

Because social security is sacred, because seniors vote in disproportionate numbers, and because, as Michael Moore's, "Sicko" so ably demonstrated, even Republicans love their momas, the cola increases to social security were generally accepted to be actually a little bit higher than inflation.  In other words, social security recipients get not only an increase in cash payments, but a tiny annual increase in their actual standard of living or purchasing power.  But as pointed out, this is primarily symbolic because the amount is really small.  This is what's "on the table."

One of the ways that the consumer price index overestimates inflation is that it is not dynamic -- that is, it does not have a feed back measurement of how consumers change their behavior as prices change between substitutes.  The classic example is beef and pork -- both red meats.  If there is a sale on beef at the supermarket, then the amount of beef consumers purchase relative to pork goes up.

The chained consumer price index that is being discussed makes complicated mathematical adjustments to the basket of goods and services that consumers buy in order to reflect this "substitution" effect caused by price changes.

I can already hear the gnashing of teeth and rending of garments -- what if the seniors substitute cat food for beef?  Is that what we want to build into the social security cola?

The reason that won't happen is because the chained CPI deals with actual substitutes.  Cat food is not a substitute for beef.  Potatoes are not a substitute for pork.

(By the way, I've never understood the sloganeering over calling conservative proposals to social security the cat food commission.  Cat food and dog food are more expensive than human food, at least in my neighborhood.  That's why I make my dog home made dog food.  Chicken quarters are about 40-80 cents a pound depending on sales and price changes and dog food is always over a dollar a pound, and cat food is even more expensive ...  Oh wait, where was I....)

So how much will using the chained CPI affect recipients of social security?

The typical different between the current CPI and the chained CPI is about .3%-.4%.  

In other words, the difference in the increase in benefit would be about 30 cents to 40 cents per $100.  

But keep in mind that this is not a cut in benefits.  It is a decrease in the amount of increase in the benefit.  

The change from CPI to chained CPI would never result in a senior's benefit going down; only in years in which the senior receives an increase in benefit as a result of a cola, their increase would be less than would be expected under the old CPI.

Now I think we should have a policy debate about whether social security should be designed not just so that seniors maintain their standard of living but have a constant increase in that standard of living.  But if you want to make that argument, then the chained CPI isn't really the place to make it.  There have been some interesting statistical experiments with a proposed CPI-E -- that is a consumer price index calculated for what the elderly purchase, which would, for example, be weighted toward medical expenses and excessively colorful polyester shirts (just kidding about the last item).  

So what do these numbers mean in concrete terms?

Because of deflation resulting from the recession, recent cola's and CPIs are not useful (there have actually been no increases in some recent years).

But in a typical year before the recession, let's posit an average monthly social security payment of $1,044 (this is based on a google search of payouts in 2007).  That meant an annual benefit of $12,528.

The cola for 2007 was 3.3 %.

This increased the benefit by $413.42 per year, or $34.45 per month.

Remember, the difference between the old CPI and chained CPI is about 30 cents to 40 cents per $100, and you begin to get the drift here.  We're talking a few dollars a year adjustment.

Let's take the higher estimate of the difference between the chained CPI and the old CPI of .4%.

Because of the chained CPI, the recipient would receive 14 cents a month less of an increase or $1.65 less per year.

But keep in mind, this is not the beneficiary's check going down by 14 cents a month; it's that it didn't go up by 14 cents more.

In other words, the beneficiary received a  $34.31 increase, instead of a $34.45 increase.  

For raising this possibility, we are told today that President Obama has committed political suicide.  On purely political grounds try explaining why seniors would revolt over not receiving 14 cents additional monthly benefit when their checks went up by $34?

Answer: They will revolt if the professional left and perpetually disappointed scare the bejesus out of senior citizens about cuts to benefits without mentioning that the cuts are 14 cents less of an increase out of a $34 increase -- ya know, kind of like what Fox News, the Tea Party and Sarah Palin did with "death panels."

UPDATE for the numbers.

Since I've been accused of making up the numbers, I am posting below my sources.  Keep in mind that the calculations are not difficult.  It's just a matter of multiplying the typical benefit by the typical cola.  Then multiply the cola by the difference between CPI and the proposed chained CPI, which all the sources I've seen state as .3% to .4%.

Funny that all week I've been reading diaries demonizing the chained CPI which was confidently stated to be the proposal, that the chained CPI was everything.  Many of the comments now state that "we don't know" whether the issue is the chained CPI.

Oh well.

Also, I think it's a brilliant stroke of 11 dimensional rope-a-dopey-republican that the administration "chained" (pardon the pun) the cola recalculation to using the chained CPI for tax bracket creep -- in effect, raising income taxes on the affluent.

http://www.bls.gov/...

http://www.bls.gov/...

http://www.ssa.gov/...

http://www.ssa.gov/...

UPDATE 2

Thanks for putting this on the Rec List !  

Also, I changed the two numbers in the intro because I had done 2 separate calculations and I needed to make the intro conform to the conclusion.

Also, I should clarify that I did have a paragraph about how we need to have a policy debate about whether seniors' actual standard of living should be increased through colas, but many didn't seem to read that graph.  The point is that this is a different question from, the one posed by the CPI/chained CPI question -- which is, what is the most accurate measure of inflation.  

I agree with the issue of compounding, but again, keep in mind we are talking about compounding an error in estimating SSI's purchasing power.  If you want purchasing power to increase in time, let's debate that, but let's not do it through a math error, but through a policy choice.  After all, progressives are supposed to be fact based and empirical.

UPDATE 3

A few people have pointed out what they think is a math error on my part.  

Actually, if they are right, it is a writing error on the part of the BLS website, which somewhat opaquely says that the chained CPI would cause a .38 reduction in the increase in the benefit rather than a .38 reduction in the benefit.

If the BLS website is wrong, then the monthly difference would be about $4 rather than 14 cents.  

$4 in real dollar terms is significant for seniors who rely wholly or significantly on social security for basic living expenses because that could easily translate into two or three meals per month.

The problem with this extrapolation, however, is that the whole point of the chained CPI to policy wonks is that the chained CPI is widely believed to provide a more accurate measure of the actual cost of the goods and services that SSI recipients purchase.  In other words, whether the error of CPI is 14 cents or $4 is irrelevant in purchasing power terms if the wonks are correct.  The basket of goods and services is still protected.

If you want to argue that the chained CPI is wrong, then please do so.

If you want to argue that seniors should be measured by a different CPI than urban workers, such as by the experimental CPI-E (for elderly) then please do so.

If you want to argue that the old CPI provides an actual increase in the standard of living beyond the CPI, then make that argument.  You may want to remember that in my original diary I wrote this paragraph, which the emo progressives apparently couldn't bring themselves to read:

Now I think we should have a policy debate about whether social security should be designed not just so that seniors maintain their standard of living but have a constant increase in that standard of living.  But if you want to make that argument, then the chained CPI isn't really the place to make it.  There have been some interesting statistical experiments with a proposed CPI-E -- that is a consumer price index calculated for what the elderly purchase, which would, for example, be weighted toward medical expenses and excessively colorful polyester shirts (just kidding about the last item).  

But the point of the diary is that if the chained CPI is an accurate measure of the actual increase in expenses of seniors on social security due to inflation, then replacing the old CPI with the chained CPI does not result in a reduction of standard of living -- whether the nominal amount is 14 cents or $4 per month.

As for compounding, again, the question is which index is accurate.  If the CPI is inaccurate as lots of wonks say, then all you're arguing for when you point out compounding is that the original error should be compounded, not that the original error is right or the compounding is justified.

At minimum, the diary moves the discussion to a discussion of the effect of inflation on SSI, the importance of purchasing power parity, and actual numbers from "zoh my god!!! Teh evul Obama wants to kill social security, destroy the Democratic party and force grandma to eat cat food!!!  They're spitting on Ted Kennedy's grave!!!"

I also think its interesting -- and useful -- that some people tried to fact check this, but I have to note that I've rarely seen those same emo progressives fact check of certain diaries that, for example, describe collateralized debt obligations as mortgages that have been sliced and diced and "sprinkled with fairy dust."  My question would be what kind of fairy dust?  How much in percentage terms?  Was it sprinkled or sprayed?

Originally posted to HamdenRice on Thu Jul 07, 2011 at 06:28 AM PDT.

Also republished by The Yes We Can Pragmatists, Flame Free Zone, Progressive Messaging, EconKos, and Social Security Defenders.

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