A new tax reform bill references a chained CPI and is bringing changes to most taxpayers. So, what is the chained CPI, what does it have to do with retirement income for a fed, and what does the new tax reform bill have to do with a chained CPI?
A consumer price index (CPI) determines the amount of any cost of living adjustment, but there are different CPI indices.
A CPI changes with the rise and fall of expenses for fixed items. A “chained CPI” does that but also considers “choices” people make because of behavioral changes. An example is if the price of beef increases, people may buy chicken instead because it may cost less. And when the price of a product goes up, people are more likely to buy less of that product.
The chain-weighted CPI would incorporate changes in both quantities and prices of products. This results in smaller benefit increases when calculating costs for multi-billion dollar programs like Social Security or the federal retirement system.
The chained CPI is often considered a more accurate measure of inflation; however, it will not accurately reflect increases costs for older Americans.
Good and Bad of a Chained CPI
As one executive summary noted if a chained CPI was implemented, over a 10-year period the federal government would save approximately $150 billion. “Since the chained CPI grows more slowly than the traditional CPI’s, benefits and eligibility thresholds would grow more slowly, resulting in lower spending.” the summary said.
An advantage of the chained CPI is the government would spend less money. However, a disadvantage is that it would result in smaller future increases for Social Security recipients and federal retirees.
Current COLA Calculation
The COLA for the next ear is currently determined by a complex formula. It’s currently determined by calculations using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This is different than the chained CPI.
The CPI-W is used for measuring increases in prices of consumer goods like food, housing, clothing, and gasoline.
For there to be a COLA for the upcoming year, the average CPI-W for the third quarter must be greater than the highest previous third quarter.
Tax Reform Bill and the Chained CPI
While this new tax reform references a chained CPI, it does not change how the annual COLA is currently calculated. However, it could have an impact on future COLA calculations, because the bill does require that the federal government start using the chained CPI in some ways.
Effective January 1st, tax provisions are now indexed for inflation. Under this new legislation, marginal personal tax rates, tax credits, and standard deductions are indexed for inflation. The measurement for determining this rate of inflation is the Chained Consumer Price Index for All Urban Consumers. This is the first time the federal government and it is using the chained CPI. It will now be used for measuring inflation for these tax purposes.
Under these new tax rules, the standard deduction has doubled to $13,000. That’s going to reduce taxes for most taxpayers.
While this new bill will result in lower taxes for many Americans, changing to the chained CPI is probably going to have a large impact over time by reducing the amount that can be deducted.
Tax Bill and COLA’s
The new tax reform bill does not impact how the annual COLA is calculated for those receiving Social Security or for federal employees receiving an annuity from the federal government.
One big concern of those that lobby to improve or retain the current government benefits is there will be another move to change retirement COLA calculations to the chained CPI. Congress may be reluctant to make a change because there are so many who would be impacted by the change.