David: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. Since the mid-1980s, U.S. income tax brackets have been adjusted every year to account for inflation. Until now, that measurement of choice has been the consumer price index. But both the House and Senate tax reform bills have included a new measurement of inflation: the chained consumer price index, or chained CPI. What is it, and what effect will it have? Tax Notes Today reporter Zoe Sagalow is here to walk us through the issue. Zoe, welcome to the podcast.
Zoe: Thanks, Dave.
David: Before we begin, I should note that we're recording this on December 6. As of this recording, both the House and Senate have passed their own versions of the tax reform bill and a conference committee is expected to work out the differences between the two. Zoe, what is the consumer price index, and where does it come from? And what effect will changing to a chained CPI have?
Zoe: The consumer price index is calculated by the Bureau of Labor Statistics, and it's measured using a fixed set of goods -- economists always call it a fixed basket. The chained consumer price index takes into account that when prices for one good rise, consumers might substitute that good for another one that costs less. For example, suppose you go to the grocery store and normally you buy beef, but this week you see the price has gone up for beef, so then you might decide to buy chicken this time because it's less expensive.
David: How much of a difference does this measurement make?
Zoe: Well, chained CPI tends to grow about 0.2 percent or 0.3 percent slower, so that's why income tax thresholds for the tax brackets would increase by smaller amounts each year. And the increases each year in the size of the standard deduction would be smaller, too.
David: Now, that difference sounds pretty small, but I take it, it adds up over time.
Zoe: Yes, exactly. Marc Goldwein of the Committee for a Responsible Federal Budget, a think tank, told me that in the tenth year, after the change to using chained CPI, the standard deduction would be 2 percent or 3 percent lower than it would've been if we had continued using the previous measure of inflation.
David: Why are lawmakers proposing this change now?
Zoe: Well, the Joint Committee on Taxation has scored the tax bills, and the revenue it estimates these provisions would raise is somewhat substantial. The estimate of the provision in the House bill was that this provision would raise about $128 billion over 10 years. And in the Senate bill, it's estimated to raise about $134 billion over 10 years. But that estimate of the Senate bill doesn't yet take into account any potential impact from keeping the individual alternative minimum tax. Keeping the individual AMT is one of the newer provisions that chained CPI would now apply to in the Senate bill.
Another reason to propose this change is the economic argument that chained CPI is a more accurate measure of inflation. This is what Goldwein at the Committee for a Responsible Federal Budget told me. CPI that is not chained CPI usually compares people's spending with their spending in the previous year, which Goldwein said would tend to overstate inflation. He also pointed out that if you were to instead compare people's spending with next year's spending, that would understate inflation.
David: Now I know I've heard this debate about changing the inflation measurement before. Where has it come up?
Zoe: Yes, there's been talk of using it before. President Obama proposed applying chained CPI to tax brackets as part of his fiscal 2014 budget proposal. And even earlier during the 2011 deficit talks, changing to using chained CPI as the federal government’s measure of inflation actually had bipartisan support. That change would have restricted the growth of benefits for Social Security. At this point, though, Congress is just considering using it on the tax side, not on the spending side.
David: So some see chained CPI as a more accurate measurement, and that it also increases revenue. What is the counter-argument?
Zoe: Well, Paul Van de Water at the Center on Budget and Policy Priorities explained that because chained CPI as a measure of inflation grows more slowly, taxpayers would move up into higher and higher marginal tax brackets faster. So they would have to pay more in taxes. Now, while Goldwein had said that chained CPI is more accurate, Van de Water said it's probably more accurate in some cases, but not in others. Van de Water was also concerned that chained CPI will start to be used for spending bills rather than just tax bills. And he's concerned, for example, that it will be used for Social Security, as was proposed in the past. And he thinks that would have a disproportionate effect on low-income people.
David: Now, congressional Democrats have been largely left on the sidelines in this tax reform debate, but what have they said on the issue?
Zoe: Well, Rep. Earl Blumenauer, he's a Democrat from Oregon on the House Ways and Means Committee, has criticized the use of chained CPI as a measure of inflation. He pointed out that it's a lower adjustment and over time it would pull taxpayers into higher brackets because of inflation. He's also concerned about the increase in the national debt in the tax bill, and he's concerned that using chained CPI would make that even worse. He pointed out that Congress has authorized an increase in the budget of $1.4 trillion, but because of inflation, that would grow to $2 trillion, he said.
David: Would it be safe to say that moving to a chained CPI is a done deal, at least for tax policy?
Zoe: Probably, yes, given it's in both the House bill and the Senate bill. If tax reform passes, it's safe to say it will be included in the final bill.
David: Zoe, where can listeners find you online?
Zoe: You can find me on Twitter @thesagaofzoe. That's Z-O-E at the end.
David: Thank you for being here. That's it for this week. You can find me on Twitter @TaxStew. That's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org.
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