Updated Version of "Measuring Up: The Case for the Chained CPI"
Currently, the federal government relies on two cost-of-living measures for most inflation-indexed spending programs and provisions of the tax code: the CPI-U (Consumer Price Index for All Urban Consumers) and the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers).
The CPI-W is used to calculate COLAs for Social Security and other federal retirement programs, while the CPI-U is used to index various provisions of the tax code, as well as poverty thresholds. The CPI-U is considered to be the more accurate of the two, since it covers 87 percent of the population, compared to the 32 percent covered by the CPI-W.
The Bureau of Labor Statistics (BLS) formulates these price indices by creating a representative “market basket” of goods based on the covered population’s consumer spending patterns; in the case of the traditional CPIs, this data is available with a two-year time lag. Then, using this market basket, BLS tracks price changes for the included items over time. BLS follows the prices of goods in the market basket, and measures inflation based on the overall change in the price of the basket.
In 1996, the Advisory Committee to Study the Consumer Price Index (the Boskin Commission) found that both CPI-U and CPI-W overstated inflation in a number of ways, which they estimated to total about 1.1 percentage points per year. The Bureau of Labor Statistics responded by making a number of changes to the way they measured CPI-U and CPI-W, which corrected much of the biases in the two indices.
However, a portion of the bias – upper level substitution bias for changes between categories – cannot be addressed through the existing CPI-U and CPI-W for technical reasons. Instead, BLS created a new measure of inflation – the chained CPI (also known as the superlative CPI or the C-CPI-U) – in 2002 to account for consumer substitution between categories. This measure has been refined and improved since it was initially published. Unlike the methodological changes in the calculation of CPI-U and CPI-W that are automatically reflected in the published measures used for indexing programs under current law, using the more accurate chained CPI for indexation instead of the CPI-U or CPI-W requires a statutory change in law.
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