The Consumer Price Index (CPI) and the
unemployment rate are the two most important economic statistics
produced by the Bureau of Labor Statistics (BLS) in the U.S.
Department of Labor. The CPI--a weighted measure of the average
monthly change in the price of a fixed market basket of goods and
services
--is important because it is a central target of monetary policy,
and because changes in the CPI will significantly affect government
data and the public policy debate surrounding such issues as real
wage and income growth. For example, overstating
inflation by 1.1 percentage points per year from 1973 to 1995 would
mean that real inflation-adjusted hourly wages have actually
increased 13 percent instead of falling by 13 percent as is
currently reported.
An
inaccurate CPI has major implications for the federal budget. In
the current fiscal year, approximately 30 percent of total federal
spending is indexed to movements in consumer prices. Social
Security, Supplemental Security Income (SSI), veterans pensions,
military retirement, and civilian pensions account for the bulk of
this spending. Tax receipts are also affected, since individual
income tax brackets, personal exemptions, and the standard
deduction are adjusted--that is, indexed--according to the CPI.
Individual income taxes account for about 45 percent of federal
receipts.
There is a widespread consensus that the
CPI significantly overstates the rate of increase in the cost of
living. This problem received a great deal of attention following
the release of the Boskin Commission Report--the Final Report of
the Advisory Commission to Study the Consumer Price Index--in 1996.
The Boskin Commission Report concluded that the CPI overstates
inflation by 1.1 percent a year. In addition, the weight of
evidence emanating from the academic community, the Federal
Reserve, the Congressional Budget Office (CBO), and even the BLS
that the CPI has an upward bias is overwhelming. The upward bias
has, and will continue to have, significant implications for public
policy decisions. Even after the next set of revisions in the CPI
is completed in 1999, significant upward bias will remain.
The
significant overestimate of the increase in the cost of living
results because of a variety of methodological problems that occur
when the CPI is calculated. To its credit, the BLS has a
program of research and development activities aimed at improving
the accuracy of the CPI. And since 1990, the BLS has implemented a
number of improvements in addition to the soon-to-be-completed
six-year CPI revision program. The combined effect of all these
improvements is expected to reduce the rate of increase in the CPI
by 0.7 percentage points per year compared to the early
1990s.
These changes alone will raise federal revenues by $35.4 billion
and reduce federal spending and interest payments by $61.6 billion
between now and fiscal year (FY) 2003 (see Chart
1).
The
increased focus on the CPI that followed the release of the Boskin
Commission Report caused the BLS to begin a new multiyear CPI
Improvement Initiative in 1998. The BLS received $2.1 million for
the project in its first year; it has asked for $9.1 million for FY
1999. According to the BLS, these funds will expand the Consumer
Expenditure Survey to facilitate more timely CPI market basket
updates and the production of an official superlative index that is
more accurate than the current CPI. The new funding will also
enable the BLS to expand the use of quality adjustment
methods.
These are positive--but long overdue--steps that will further
minimize bias in the CPI.
How to Improve the CPI
Improving the Consumer Price Index will
involve both the executive branch and Congress. Research and
development activities that address the existing methodological
problems must be undertaken by those in the executive branch who
have relevant expertise. At the same time, by exercising its
oversight responsibilities, Congress should ensure that the federal
resources dedicated to such an effort are used effectively to
achieve the desired goal of improving the quality of the CPI. The
measures that can be taken include the following:
-
The Bureau of Labor Statistics
should establish a new index, to be published and updated annually
and revised historically as far back as possible. This
index should take into account all of the changes made in the CPI
since 1990 and any future improvements that are made in the
official CPI. It could then be used much as the current "CPI-U-X1"
index (which measures housing costs the same way from 1967 to the
present) is used--as a deflator in economic research.
-
The President and the Secretary
of Labor have authority to direct the BLS to correct the CPI as
part of the current improvement initiative. One of the
Secretary's primary goals in improving the CPI should be to create
an index that more accurately reflects changes in the cost of
living. A perfect cost-of-living index is not possible in a complex
economy, but the BLS should continually strive for that goal.
-
The Secretary of Labor should
establish a permanent and rotating independent commission of
experts to review progress, conduct research, and make
recommendations for further improving the CPI. The
commission should be appointed by either the National Bureau of
Economic Research or the National Academy of Sciences and should
report to Congress once a year. If the Secretary of Labor does not
establish such a commission this year, Congress should implement
one through the appropriation process with the reprioritization of
existing resources. The 30-year span between the last two major
commissions--the Stilger and Boskin Commissions--was far too long
for comprehensive evaluation of the CPI. The BLS needs a more
permanent, ongoing mechanism for bringing in outside information,
expertise, and research to improve the CPI on a more timely
basis.
-
Congress should establish an
oversight process and appropriate additional funding for the CPI
improvement initiative and the permanent commission from within the
existing discretionary budget. Even though legislative
action, such as modifying the inflation adjustment for Social
Security benefits, is not necessary at this time,
congressional oversight is critical. Congress should establish an
annual oversight process that includes a General Accounting Office
(GAO) review of how well the BLS strategic plan and performance
plan meet the criteria in the Government Performance and Results
Act of 1993 (GPRA). The most recent GAO report found that the BLS
plan "did not fully portray how BLS' strategies and resources would
help achieve the performance goals for improving CPI
quality." Annual oversight hearings should
be held to determine whether the BLS is fulfilling its GPRA
requirements.
Conclusion
A
major problem with the federal budget is not the Consumer Price
Index itself, but how the CPI is used. Although Congress explicitly
intended to insulate program beneficiaries and taxpayers
automatically from the effects of inflation, it chose a mechanical
process that does not accurately account for changes in the true
cost of living. The Secretary of Labor and the BLS can and should
make improvements in the CPI, including striving to achieve the
goal of developing a more realistic cost of living index. At the
same time, Congress must conduct effective oversight and make it a
priority to keep such an index up to date. Even if the upward bias
in the CPI is only a fraction of a percentage point per year, the
relentless compounding of such a bias ultimately will have
significant budgetary consequences.
D. Mark Wilson is the former Labor Economist at
The Heritage Foundation.
Endnotes