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How Different Is Grandma’s Spending?

Saturday, October 17, 2009

The inflation seniors experience is far more similar to that felt by other Americans than it is different.

In announcing his support for a $250 ad hoc COLA payment for all Social Security beneficiaries, President Obama cited higher prices for healthcare, on which seniors spend a larger share of their incomes. Likewise, USA Today quoted the National Committee to Preserve Social Security and Medicare:

Seniors' groups argued the one-time payments are justified because, although inflation has been flat, medical costs have risen by more than 3 percent. “Seniors aren't buying iPods,” said Barbara Kennelly, president of the National Committee to Preserve Social Security and Medicare. “They're staying healthy by buying prescription drugs.”

Another seniors group, the AARP, held similar views:

"Without relief, millions of older Americans will be unable to afford skyrocketing healthcare and prescription drug costs, as well as other basic necessities," said Tom Nelson, chief operating officer for AARP.

Finally, my old boss at the Social Security Administration, the excellent Social Security Commissioner Mike Astrue, made a similar point: health costs, he said, have risen “at a rate of inflation much higher than any other commodity.”

Okay, but how well does this argument hold up? It is true that seniors spend a greater share of their incomes on healthcare than do working-age Americans. The chart below draws on the CPI-W, which is used to calculate Social Security COLAs and is based on the spending of working-age Americans, and the experimental CPI-E, which is based on the spending of Americans over age 65. There are clear differences: working age individuals spend more on transportation, for instance, while seniors spend more on medical care.

Chart A.10.17.09

But should these differences lead one to conclude that seniors should have received a COLA this year? After all, seniors do not spend all their income on healthcare—the prices of other goods and services matter as well.

The chart below shows the CPI-W and the CPI-E from July 2007 through July 2009. (It also includes the C-CPI-U; more on that below.) I centered both series on 100 as of July 2007 to provide a feel for how they changed over that period.

Chart B 10.17.09

While the two inflation series varied at times, what is extraordinary is how little they differed. Both rose through mid-2008 as energy prices increased and both plummeted in late 2008 as prices crashed. The final values as of July 2007 (the last month for which I have CPI-E data) differed only slightly: the overall price level under the CPI-E was just 0.17 percent higher than that of the CPI-W.

Even if Social Security used the CPI-E rather than the CPI-W to calculate COLAs, there would be no COLA paid this year and potentially no COLA next year as well. (In addition, the 5.8 percent 2009 COLA would not have been nearly as large.)

Moreover, there is good reason to believe that both the CPI-W and the CPI-E overstate the true rate of inflation, as they do not fully account for how consumers change their buying habits as prices change. Let’s say the price of oranges rises while the price of apples stays the same. The CPI-W and CPI-E assume people buy just as many oranges as before, which implies higher overall prices. In reality, people will buy fewer oranges and more apples, so their true cost of living won’t rise nearly as much.

To account for these dynamics, the Bureau of Labor Statistics produces an alternate series called the “chained” CPI, or C-CPI-U. While it also follows a similar path to the CPI-E and CPI-W over the last two years, as of July 2009 the overall price level in the chained CPI was 0.6 percent below the CPI-W and 0.7 percent below the CPI-E. In other words, it is easily possible that the true rate of inflation experienced by seniors is lower than shown by the CPI-W, not higher. The statements above reflect a common misperception that seniors are nothing but healthcare consumers, when in fact they buy many of the same products as working-age Americans—including, yes, iPods. For that reason, the inflation they experience is far more similar to that felt by other Americans than it is different.

Andrew G. Biggs is a resident scholar at the American Enterprise Institute.

FURTHER READING: Biggs’s new AEI paper on the Social Security COLA includes additional discussion of measuring inflation for retirees. In “The Straw Men of Social Security,” the author argues Social Security badly needs reform.

Image by Darren Wamboldt/Bergman Group.

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