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President Obama's new budget proposal includes changing a couple of key inflation calculations to something called a "chained CPI." The shift is getting a lot of attention right now because of the expected effect it will have on individuals.

There are two key places where a chained CPI -- short for consumer price index -- will have a direct impact on your pocketbook: income taxes and Social Security benefits. All else being equal, over time, your income taxes will be higher and your Social Security benefits will be lower than they are under current inflation calculations.

The key difference between the chained CPI and the traditional consumer price index is how the index measures consumer behavior. The chained CPI assumes that as prices rise on one product, some portion of consumers will be willing to substitute less expensive alternatives for what they used to buy.

That changes the product weightings used in the inflation calculation. By incorporating information from those new product weightings, the chained CPI typically produces a lower inflation level.

Here's how it works.

The Impact on Income Taxes

If you pay income taxes, your tax bracket is determined by the amount of taxable income you make. The cutoffs for each bracket generally rise over time with inflation.

The two charts below show the IRS "Schedule X" brackets for single taxpayers; the first is for 2012, and the second is what's currently expected for 2013:
IRS Chart
Chart for 2012 from the U.S. Internal Revenue Service
Chart for 2013 from the US Internal Revenue Service
Chart for 2013 from the U.S. Internal Revenue Service


While the 39.6 percent tax rate is new for 2013, note that the other brackets have higher cutoffs for 2013 than they did for 2012. That's thanks to the inflation adjustment made to the tax brackets.

If the law is changed so that the chained CPI is used, the tops of those brackets are expected to rise more slowly, exposing more of your income to higher tax rates than under current law.

The Effect on Social Security Benefits

Similarly, Social Security benefits are increased based on the inflation rate. By tying the payment increases to the chained CPI -- an inflation rate that grows more slowly than the current measure -- those benefit payments will grow less quickly as well. As a result, over time your Social Security checks will be smaller than they would have been under the old inflation calculation.

The annual changes aren't too extreme -- they're estimated to be somewhere in the vicinity of 0.1 percent to 0.3 percent per year, depending on what the future brings. But over time, it adds up to real money for those who pay income taxes or receive Social Security checks, with official estimates in the neighborhood of $340 billion in higher taxes and lower costs over the next 10 years.

Is It Better? Is It Fair?

To some extent, the chained CPI is more effective at measuring the behavior changes that we all make whenever possible to save some cash.

For example, if you've switched to generic medications whenever they're available, you're doing exactly what the chained CPI expects you to do. Likewise, if you started carpooling or taking the bus in response to higher gas prices, you're changing your behavior based on higher prices, just like the chained CPI projects.

On the flip side, of course, not all costs are easily switchable, especially for the seniors who rely on Social Security. For instance, health care costs have been rising faster than the overall inflation rate for decades, and older folks generally have higher health care costs than younger ones do. As a result, the change to a chained CPI will very likely make the gap between income growth and health care spending growth even more painful for seniors on Social Security.

The Big Picture

Still, if slowing the rate of benefit increases puts off the day of reckoning for when the Social Security Trust Fund runs out of cash and slashes benefits by around 25 percent, it may be worth it. That date is currently estimated to be a mere 20 years away -- well within the expected life span of most current workers and even some early retirees. To make it worse, if the CBO's recent release on Social Security is any indication, the next Social Security Trustees' Report may even pull that date even closer.

Given a choice between a slower rate of growth or a hard slash of 25 percent at some point in the not-too-distant future, neither option seems ideal. But still, a slower rate of growth is a lot less painful than waking up one day to find your sole source of income has shrunk by a quarter of its former value.


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49 Comments

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Paul

Remember it is NOT Obama's fault. We did NOT vote for him either time! It is the fault of our CONGRESS for spending the $$ in the S.S. Fund to begin with. Remember it is YOUR $$ not the federal government's. It is $$ that you and your Employer sent to Washington D.C. for them to hold, etc. (NOT SPEND)

April 26 2013 at 4:46 PM Report abuse rate up rate down Reply
hpiercy

Un elect the thieves that continually take funds that we and our employers paid for us to enjoy. It matters little how much is in your Social Security account, it matters that it is your money, and not the governments, to spend, or "reallocate". I urge everyone, regardless of age,to think about what is happening. If they can take your money, and spend it on whatever they want, imagine what their next ponzie scheme might be.

April 25 2013 at 10:02 PM Report abuse rate up rate down Reply
Wayne Ostrander

What the article did not mention is what major changes will happen when the flood of illegal aliens suddenly are declared legal. That will add over twelve million more individuals that suddenly will qualify for Social Security, and we must not forget that they will be eligible instantly to bring their immediate family members to the United States, as well. In addition, since the majority of illegals are at the lower end of societies job opportunities they will be adding much less into system. This also affects other monetary areas such as for aid or social welfare programs that will also be demanding additional monies from government coffers.

Wayne

April 25 2013 at 5:32 PM Report abuse rate up rate down Reply
Mohan Gokul

correct of that..

April 23 2013 at 7:32 AM Report abuse rate up rate down Reply
alycemd

Social Security COLAs should be based on the CPI-E, not the chained CPI. It covers what the elderly buy most, like food, housing, medications, healthcare, etc. Encourage your Representatives to pass the Protecting and Preserving Social Security Act, which will do just this, as well as lift the earnings cap. Social Security would then be solvent FOREVER!

April 11 2013 at 1:09 AM Report abuse +3 rate up rate down Reply
flfisherjc

If anybody, no matter what party, believes anything from obama is good is a total idiot. He is also the biggest liar I have ever seen in any office, even private.

April 11 2013 at 12:37 AM Report abuse -1 rate up rate down Reply
Terri

Beware! 2016 movie is coming true!
Beware! Obama wants us poorer than dirt and he's causing this faster & faster; seat belts won't stop the killing that is about to happen.
Beware!
Nice to know that this won't effect the prez, congress or any ya-hoo in D.C.
Must be nice for them to live without a conscience!
Beware! Because your future of free things just cost you your freedom!

April 10 2013 at 10:21 PM Report abuse -1 rate up rate down Reply
bgdg3825

before anyone bothers to comment I mis- typed the and borrowed

April 10 2013 at 9:49 PM Report abuse rate up rate down Reply
1 reply to bgdg3825's comment
atuu

that is good for the typo police.

April 11 2013 at 12:00 PM Report abuse rate up rate down Reply
bgdg3825

Shouldn't the government pay back the billions it has borrowede (stolen?) from thew Social Security System befor it calculates a date that the fund will no longer be able to pay promoised benefits? By tghe way what happened to the President's campaign pledge not to put Social Security cuts into his budget?

April 10 2013 at 9:48 PM Report abuse +2 rate up rate down Reply
whitneygre

As they say, figures don't lie, but liars figure. Government statistics can never be trusted! Like when unemployment goes down .1% and those on disability go up .2%

April 10 2013 at 8:44 PM Report abuse +1 rate up rate down Reply