US Inflation Index May Be Overstated

Social Security and taxes could be affected

Warning: Your federal taxes could rise faster in the near future. And your Social Security payments may grow more slowly.

That's the bad news. The good news is the American economy may be a lot stronger than anyone realized. And the federal deficit could shrink dramatically - perhaps more than $600 billion over the next 10 years.

All these changes could spring from a new Senate-sponsored study that is expected to recommend a controversial step: Require Uncle Sam to measure inflation in a different way.

The change sounds arcane. But no one doubts its importance. It could have big-time effects on every family in America, from Wall Street to Main Street.

The report, certain to be controversial, will be released Wednesday by the Commission on the Consumer Price Index. It will claim that the federal government has been exaggerating US inflation by 1 to 1.25 percent a year.

A small mistake? Not at all. It's worth billions to government, to taxpayers, and to business.

Because Social Security payments to retirees are adjusted upward for inflation every year, the report could mean that future payments will increase less rapidly. And because tax brackets are adjusted every year for inflation, it means that every taxpayer in America has been paying less than was due to Uncle Sam.

All that could now change - and the results could cut the federal deficit by $600 billion or more over 10 years.

Critics already are accusing those who want to change the inflation adjustment of seeking a back-door way to cut Social Security and boost taxes.

Dean Baker, an economist at the Economic Policy Institute, a left-of-center Washington think tank, opposes any change in the consumer price index (CPI) by Congress. If changes are made, he wants it done by experts at the Bureau of Labor Statistics. He argues that there could currently be as many downside biases built into the CPI as there are upside biases.

He expects the commission's recommendations to get a push by the Republican-controlled Congress. The White House, he says, has left its options open on the proposals. "President Clinton has been careful not to rule them out," Mr. Baker says.

The Senate Finance Committee appointed the commission in June 1995 to look into the question of whether the CPI was overstated. The commission is headed by Michael Boskin, who was chair of the Council of Economic Advisers under President Bush and is currently a professor at Stanford University in California.

An interim report by the commission in September 1995 held that the current high-side bias in the CPI was between 0.7 and 2 percentage points a year. The final report will put the bias at between 1 and 1.25 percent, according to David Wyss, an economist with DRI/McGraw-Hill in Lexington, Mass.

Mr. Wyss says the average Social Security pension of about $170 per week might go up $2 less each year using the new figures. Taxpayers could see their bill rise an average 0.5 percent each year from what it would be without the change.

These savings and extra revenues would cut the federal deficit $628 billion over 10 years if the inflation gauge is changed by 1 percent.

Many government spending programs, including Social Security and the pensions of federal employees, are indexed to the CPI. Income tax brackets and personal deductions are also indexed to the CPI. These, too, are increased each year to stop "bracket creep" - raising the real burden of taxes when wage increases are weighted against inflation.

If the Boskin thesis - that inflation is overstated - wins widespread acceptance, then Washington could lower the amount of indexation with less fear of political repercussions.

"It is a quick fix. It is very attractive politically because it is hard to argue with," Wyss says. "Politicians could say it is not unfair because government has been overpaying."

Some experts suggest the government has erred even more than the Boskin commission says. Leonard Nakamura, an economist at the Federal Reserve in Philadelphia, estimates that inflation was overstated by 1.25 percentage points a year in the 1970s, and even more (2.75 percentage points) now.

Mr. Nakamura told The New York Times that if this is true, government reports that show wages declining by 9 percent since 1975 are not true. Instead, wages would have gained 35 percent since that time.

Looking at Social Security, Wyss says that recalculating inflation rates means that the Social Security fund would not run out of money to pay baby boomers' pensions for an extra 20 years, to about 2030. He says the commission will suggest that the government establish another index, a "cost-of-living index," in addition to the CPI. This would "not mess up" private contracts. Union workers, for example, would still get raises outlined in their contracts according to the CPI. But the government would use a new index to eliminate high-side biases in the CPI.

Once the impacts of the pension and tax measures are better known, opposition could build, he maintains.

Criticism could also develop among economists, Baker says. Relatively few economists, five of them on the commission, others in government, are experts on the complexities of measuring inflation. But the economics profession in general would be greatly affected. That's because factors creating a bias in inflation statistics apply to past numbers as well as current numbers. It would show, he holds, that economists have not just erred slightly in their measures of productivity, growth rates, factors affecting growth, income levels, etc. They "missed the boat."

It will "change nearly everything we thought about the economy," Baker says. It means that "more than half" of the nation's families were below the current poverty level as recently as 1962. And applying the bias to Social Security Administration wage projections puts the average annual wage at $80,000 in 2030 (in 1996 dollars). Thus workers could easily afford higher Social Security taxes to pay baby-boomer pensions.