Asymmetrical Information - Megan McArdle

12.19.12

What's to Like About the New Proposal for Cost of Living Adjustments?

Changing COLA formulas represents one of the better options for entitlement reform

So it looks like one of the proposals for a fiscal cliff deal is going to be using chained CPI to calculate Social Security cost of living adjustments.  

What is chained CPI, you ask, and well you might. Here's a pretty good primer. The important thing, for our purposes, is that it results in a slightly lower inflation number--which means, in turn, lower cost of living adjustments for seniors. Over time, that can add up to big savings.  

Progressives are understandably livid: if you don't want benefits cut, then doing it this way rather than some other way is not going to make you particularly happy. And there is some complaint that chained CPI may be harder on seniors than young people, since it's hard for them to shop around for better deals on health care the way regular consumers substitute chicken for beef when the price of steak goes up.  

But the truth is that spending cuts have to come from somewhere, and what we spend most of the government's money on is old people and the military. Which means that one way or another, we're probably going to have to take some money from old people if we want to close the budget deficit. Is this the right way to do it?  

I say yes. Changing the COLA formula has two great advantages over other potential cuts: it is automatic, and it is very gradual. This makes it politically easier, but more importantly, it makes it easier on the pensioners, because it gives them time to plan.  

Even if you think that Social Security and Medicare are terrible programs which should never have been enacted, the fact is that they were, and people have come to depend on them. You cannot simply yank the program away, or slash benefits in half, because it takes time to plan for retirement; if you're 68, it's way too late.  

The change to the COLA formula, on the other hand, diminishes the value of benefits to something more affordable, but slowly enough that middle aged people have time to see it coming and raise their savings. This is the right way to do it.  

Of course, one could argue that it's not enough: we have a trillionish deficit right now.  But we shouldn't have a problem financing shorter term borrowing if we can show the markets that over the long term, we really do have a plan not to need trillions and trillions more.