Saturday, July 23, 2011

Well, if they are just going to snipe at each other, I guess it is up to me to actually explain one of the most important parts of Social Security and Medicare reform...

One of the proposals to slow down the rate of spending, and technically not "cut" benefits, on the two major entitlement programs (Social Security and Medicare) is to go to an alternative measure of prices that reflects substitutes and presumably closer reflects the rise in the cost of living. Exciting, isn't it? Maybe not, but it is a major component to entitlement reform AND almost no one talks about it or explains it.  Here is my superfluous effort...

When the time rolls around for Congress to adjust the amounts (also known as "Indexing")senior citizens receive for Social Security and Medicare benefits, they use the Consumer Price Index(CPI)---a measure of a fixed basket of typical goods and services that the average person might purchase on a daily, weekly, monthly or yearly basis.  If in a time period the market basket costs, say, $100 and in a subsequent time period the SAME basket costs $110, then is can be said prices overall have increased 10%. Congress then can increase the benefits received by senior citizens 10%.

The problem in this measure of prices is the word "fixed".  In the real world, if the price of a good increases consumers seek, and often find, less expensive alternatives. The CPI does not reflect this. In effect the CPI may overstate inflation. Hence, in our example above, if a consumer chooses a less expensive alternative not in the fixed basket then inflation may have increased only to, say, 8%.

Under this new measure, the senior citizen receives an 8% increase in benefits as opposed to 10%.  Voila, proposed spending is reduced by 2 percentage points (or 20%!)...

Hope this helps in seeing the "policy forest" for the "political trees"...
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