This is one of the very terrors of the modern age apparently – that Donald Trump’s Administration is considering changing the details of an inflation calculation. This will mean that, over time, the poverty line rises less swiftly. That, in turn, will mean a lowering of the amount that people can gain in welfare benefits – assuming their income is static that is. This is terrible, awful, apart from actually being the correct decision to be making that is.
Firstly, we know that CPI itself decidedly over estimates inflation:
The CPI is the most important measure of inflation the federal government publishes. The widespread use of the CPI to index components of the federal budget means that
errors in measuring the CPI have potentially large budgetary implications. The CPI is used to index personal income tax brackets and Social Security and other welfare
payments so as to protect taxpayers and Social Security recipients from
the pernicious effects of inflation. The idea here is that a taxpayer’s
liability should not increase just because the price level has increased,
if the real purchasing power of his or her income has not gone up also.
On the benefits side, the idea is that Social Security recipients are
entitled to some real amount of purchasing power rather than a
nominal amount whose purchasing power is systematically eroded by
inflation. However, insofar as the price index used to compensate taxpayers and Social Security recipients for increases in the cost of living overstates the rate at which prices
are increasing, taxpayers and Social Security recipients are being overcompensated for inflation and are effectively receiving an additional subsidy from the government. As
noted earlier, the potential magnitude of these excess transfers is quite large, and their elimination could go a long way toward eliminating the budget deficit.
Evidence that the CPI overstates the rate of increase in the cost of
living is remarkably thin. Researchers do know that, as a result of various
types of substitution behavior, the CPI overstates the rate of increase
in the CPI by as much as 0.6 percent a year. They have no idea, however, how much quality change and the emergence of new goods adds to this bias. It could be as much as
an additional 0.4 percentage points a year, and it could be zero.
Yes, it does over estimate and yes, it is important. Specifically, it over estimates by not accounting for substitution properly. So, changing that measure would be a good idea. Because we do like accuracy in such things, obviously. But also because we’re never going to deal with reality well unless we do attempt some accuracy in our descriptions of it.
So, this sounds good then:
WASHINGTON—The Trump administration is weighing changes to a federal poverty measure that could reduce eligibility for a number of federal safety-net programs. The administration is seeking public input on a proposed change to an index used to gauge inflation for a U.S. poverty measure, according to a notice Monday in the Federal Register. The measure is used to determine financial eligibility for federal programs such as the school lunch program and Head Start, and the size of premium tax credits on the Affordable Care Act…
The annual increases in spending upon all of those things have been too high as we’ve been over estimating inflation all along. Now we’re going to move to a lower – and more accurate – inflation measure, lightening the load on the taxpayers’ wallets. This is good.
Except, of course, if you’re Michael Hiltzik. For whom it is an outrage that anyone get less out of government. That for more to gain more a different and other more must pay more doesn’t seem to register:
If applied to eligibility for low-income assistance programs — food stamps, Medicaid, heating assistance, welfare — a lower official inflation rate would reduce the eligibility ceiling over time, compared with the current index. That’s important for many of the roughly 40 million people officially counted as living in poverty in America today.
The administration has tried to conceal its intentions, in its usual passive-aggressive manner. By casting its proposal as merely a request for comment on several possible changes in inflation indexes, the White House can claim it’s neutral about the choices. But most of the other choices aren’t really appropriate for any broad-based income-tested program. The filing, moreover, mentions that the chained CPI already is used by the IRS in adjusting federal tax brackets, a change mandated by the tax cut legislation of 2017. The mention, as it happens, is so obscure that only an expert in tax law would be sure to notice it.
Oh, so they’re already applying it to how much they take off of us, are they? Doesn’t that rather argue that it’s not some plot against the poor but part of a general move to a better standard of measurement? As to Hiltzik’s specific cause for complaint about the technical details:
The ostensible advantage of the chained CPI over its traditional cousin is that it takes into account so-called substitution effects. Those are what happen when a price rise in a given product or commodity prompts consumers to make an alternative purchase. Since they’re no longer making choices from the CPI’s standard market basket, the argument goes, the CPI’s inflation tracking is thrown awry. This is a poorly understood process. The traditional CPI actually does adjust for some substitutions, if they take place within categories — if Gala apples rise in price, for example, the CPI recognizes that consumers might buy Fuji apples if they’ve risen less. The chained CPI anticipates substitutions across categories — if apples rise in price, consumers might switch to bananas — or more important, if the price of food goes up, they may cut back on heating oil.
The complexities of the various CPIs sometimes flummox even experts. Back in 2011, the eminent economist Sylvester Schieber tried to illustrate how the chained CPI works for the House Ways and Means Committee. At a hearing on Social Security, he explained that the chained CPI would recognize that “if the price of a Mercedes goes up … maybe you don’t buy the Mercedes, you switch and you buy an Audi or something.” As I wrote at the time, it was hard to say whether this was a real-life event for Schieber or whether he thought that a parable about substitution in the luxury car market would hit the plutocrats on the Ways and Means Committee where they lived.
More to the point, Schieber was wrong, because substitution within categories of goods such as new cars already was baked into the standard CPI. A more accurate example would be that if the price of gas or medical care goes up, you cut back on food.
So, that’s an interesting question. Should we be including substitution effects across categories of goods? Or shouldn’t we? Fortunately, the composition of the poverty line itself tells us the answer here:
The official poverty measure compares cash income, before taxes, against a threshold that is set at three times the cost of a minimum food diet in 1963. In 2016, the official poverty measure was 12.7 percent, which meant that 40.6 million Americans were considered to be living in poverty.
Close but not quite. It was a basic but nutritious diet, not a minimum one. It included a selection of vegetables and meat from identifiable species, not just three bowls of grits every day. And don’t forget that grits and more grits was a minimum diet only a generation before – you don’t get pellagra unless you’re eating nothing but corn mush and yes, the South had pellagra well up to WWII.
It also wasn’t meant to be a poverty line measurement. It was an observation by Molly Orshansky, that poor families spent about a third of their income upon food. So, as a rough rule of thumb 3x that basic and nutritious diet would serve well as a measure of poverty. Then it just growed like Topsy and became the standard.
So, OK, the poverty line is 3x the basic diet upgraded for inflation. But are we using the right inflation rate?
Well, no, we’re not:
In 2016, Americans spent an average of 9.9 percent of their disposable personal incomes on food—divided between food at home (5.2 percent) and food away from home (4.7 percent). Between 1960 and 1997, the average share of disposable personal income spent on total food by Americans, on average, fell from 17.0 to 10.5 percent, driven by a declining share of income spent on food at home. The share of income spent on total food began to flatten in the late 1990s, as inflation-adjusted incomes for many Americans have stagnated or fallen.
Note that this is for all households. Food being an inferior good at our level of income – no, not something bad, just something we spend a smaller portion of our income on as we get richer, a normal good is one where the percentage stays the same, a luxury good one where it rises – the percentage for low income households will be higher than that average. But as we can see, food is a smaller portion of household expenditures than it used to be. The reason being that food has become cheaper over time. Vastly so compared to incomes, still very much so compared to the prices of other goods and services.
OK, but what else is this telling us? That we do have substitution across…no, let us return to Hiltzik:
The chained CPI anticipates substitutions across categories
That’s it. We have, in that real world, substitutions across categories. If we didn’t then households would, in 2019, be spending the same portion of income on food as they did in 1963. They’re not. Therefore substitution across categories happens in the real world. Since our inflation measure is attempting to measure the real world then our inflation measure should include substitutions across categories.
Pretty simple really. Oh, and Hiltzik is wrong but then we knew that.
Finally it’s worth pointing out that this is bugger all to do with the Trump Administration. No, I have no inside knowledge here but this is the sort of change in technical wonkery that takes a decade or more to work it’s way through the intestines of the bureaucracy. It also takes place at a level far below the purview of any political appointees. The initial stirrings of the worries about the inaccuracy of the CPI measure arose back in the 1990s – that I am sure of from personal memory. At least as far back as the 1990s. This is just how long it takes government to chew through such problems and solutions.
We could have Bernie as President and St Alexandria of Ocasio as his handmaiden and we’d still be seeing the same ruminations about chained CPI. Because that’s how the technocratic part of government works.