The Money Illusion

Excellent point from Kevin Drum on the Social Security COLA issue:

Still, this does go to show the power that sustained inflation holds on our imaginations. Technical arguments about CPI calculations aside, the fact is that seniors haven’t gotten a benefit increase for decades. It’s just not the way the program works. But the fact that their checks keep going up makes it seem like they have. So now, despite the fact that the huge benefit increase of last January combined with the deflation of the past 12 months means seniors really are getting higher benefits for the first time in recent memory, it doesn’t seem like it. So adjustments must be made and appearances kept up.

It is quite striking, the one year congress will intervene to give seniors a real increase in benefits is the year in which they were getting a real increase anyway. At any rate, the one-off bonus is pretty silly but even Tyler Cowen agrees that on net it’s probably fine public policy.

This is a reminder, however, that technical determinations about the inflation rate play a large role in budgetary issues. There are any number of ways of calculating the inflation rate, and even though people sometimes debate them as being better or worse, I think if you examine the issue for a little while you’ll swiftly reach the conclusion that there’s no such thing as a “true” inflation rate that different formulae are doing a better or worse job of calculating. From a hedonic point of view, relative price shifts inherently impact different individuals differently. What you really have is a range of credible approaches that make the inflation rate look higher or lower. And you can alter the long-run budget situation by switching various programs from one formula to another.

In recent years the most common proposal along these lines has tended to come from the right. You could start indexing the Social Security COLAs to a formula that shows a lower inflation rate (by accounting for substitutions—if the price of pork skyrockets but the price of chicken stays flat, most people just eat more chicken they don’t see skyrocketing food costs) and this would reduce Social Security expenditures. At the same time, Social Security benefits aren’t the only thing the federal government does that’s indexed to inflation. The cut-off points for the income tax brackets are also inflation adjusted. Before Ronald Reagan, that didn’t use to be the case. Consequently, there was a strong tendency for real tax rates to just go up over time. That allowed congress to regularly appropriate nominal tax cuts even while, objectively speaking, public revenue was growing. Since people are easily confused by inflation that was a boon to progressive policy. Congress changed that in the early 1980s. But if we shifted the tax indexing to one of the versions of the CPI that shows a lower inflation rate—for example, the aggressive C-CPI-U formula—we’d recapture some of that dynamic.