The Consumer Price Index Can't Find Its Happy Place

(Bloomberg View) -- The tax reform plans released by the House and Senate differ dramatically in so many ways, from the fate of the mortgage-interest deduction to the number of tax brackets. But the two chambers actually agree on an immensely important point: a new definition of the Consumer Price Index, or CPI.

The new version of the statistic used to calculate cost-of-living increases for all manner of benefits is dubbed “chained CPI.” Not only may it be a more accurate overall measure of inflation than its predecessor, but it makes it easier for Republicans to cut taxes without breaking budgeting rules -- by lowering price increases and therefore future spending.

But the CPI’s history reveals the dangers of selecting a single statistic to represent the economic realities of all Americans: Improving the general score often comes at the expense of specific groups of Americans, sometimes extremely powerful ones. This particular revision hammers the elderly, a group that helped elect President Donald Trump, while helping those living in Democratic strongholds.  

Government statisticians began building the nation’s first price indexes in the late 19th century. The Bureau of Labor took the lead, collecting data on the prices of foodstuffs and other commodities. But it wasn’t until 1903 that the Bureau built the first full-fledged price index. It covered 1890 to 1902, and relied on prices for some 30 different food items, each weighted by how much the average family consumed.

But what was an average family? The families surveyed by the Bureau all lived in major industrial centers; none had incomes over $1,200 a year (approximately $35,000 or so now). This wasn’t really representative. A subsequent index assembled between 1917 and 1919 was even worse: It sampled a larger swath of the nation’s geography, though limited data to families with a white male head of household.

Frances Perkins, who headed up the Department of Labor during the 1930s, grappled with much the same problem. Under her direction, a new price index built on surveys taken between 1934 and 1936 focused on families of moderate means living in cities, and headed by a male breadwinner. This idealized constituency included some African Americans, but excluded single mothers, the elderly, anyone receiving public assistance, farmers -- in fact, the majority of the population.

Not everyone was happy. Organized labor, worried about contracts tied to the CPI for cost-of-living increases, claimed the new figures underestimated inflation. Corporate economists argued that it did precisely the opposite. Meanwhile, a growing number of statisticians recognized an even bigger problem with the CPI.

A consumer price index tracks an unchanging basket of goods over time. What it doesn’t do, however, is capture changes in consumer preferences and technological innovations. For example, money spent on public transit sharply declined as owning automobiles became a norm. But a static price index that assigns a particular constant weight to a class of expenditures can’t capture that shift.

In 1959, the Office of Statistical Standards of the Bureau of the Budget convened a committee to study the problem. This group, headed by the economist George Stigler, backed the idea of  a more dynamic price index. It was the forerunner to today’s chained CPI.

By the 1970s, the Bureau of Labor Statistics grudgingly adopted some of the commission’s recommendations. It inaugurated new methods of sampling prices and simplified some categories in order to capture changes in consumer behavior. Still, the key CPI figure remained wedded to data derived from people living and working in urban areas.

Despite these liabilities, the importance of CPI grew ever larger. Beginning in 1972, Congress linked increases in Social Security benefits to the CPI, and it soon became the signal statistic for adjusting all kinds of salaries and benefits in both the public and private sector.

After yet more hearings, academic debate, another committee (the Boskin Commission), and much statistical contortions, the Bureau created a price index that did indeed capture how working-age consumers might react to price increases by substituting a cheaper item for a more expensive one (turkey for chicken, for example). This was the long-awaited Chained Consumer Price Index, or C-CPI-U (the “U” stands for “Urban”). This index yields lower rates of inflation than other versions of the CPI currently used to calculate things like the CPI-U and the CPI-W.

So why not use it across the board? Chained CPI does an excellent job of capturing the economic choices of adults currently in the workforce who live in urban areas. But the elderly? Not so much. A middle-aged man can respond to the rising price of bananas by substituting cheaper oranges, and still get the same servings of fruit into his diet per day.

Seniors can do the same, but they can’t do this with the thing that eats up a far greater portion of their income: health care. If you need heart medication, home health care for dementia, dentures, or any of the other things that become necessities for the elderly, it’s considerably harder to change your behavior to outwit price increases. Worse, the prices of those things -- which are important, but far less important to working-age people -- are rising far faster than the rate of inflation.

If anything, the existing CPI understates the effects of price increases on the elderly. It is for that reason that Congress directed the Bureau of Labor Statistics in 1987 to devise an index focused specifically on the elderly. That yielded an experimental measure of CPI known as CPI-E, which consistently yields higher rates of inflation than conventional measures. But it is still considered “experimental” – these things take time. Instead, changes in Social Security benefits remained pegged to the old-fashioned CPI. Not coincidentally, the purchasing power of those benefits has declined 30 percent since the year 2000.

Congress is poised to make a bad situation worse by adopting chained CPI. Yes, this may more accurately capture the behavior of middle-aged professionals strolling the produce aisles of a metropolitan Whole Foods. But for the elderly, this new measure may well be the least accurate measure of prices yet devised.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg View.

To contact the author of this story: Stephen Mihm at smihm1@bloomberg.net.

To contact the editor responsible for this story: Mike Nizza at mnizza3@bloomberg.net.

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