THE INFLATION MYTH

You’re adding up the numbers again, trying to figure out how to pay the bills coming due, when a man from the bank calls with a message that seems too good to be true. That calculator you got as a free gift for opening your account was, er, flawed. It has been adding up your bills all wrong and leading you to underestimate how much is left in the checking account. You can pay what you really do owe without giving up the weekly movie.

A panel of five eminent economists delivered an equivalent message to the government last week. The U.S. cost of living, said the panel, for years has been going up more slowly than the hallowed Consumer Price Index would suggest. One result is that the U.S. economy has been healthier for the past 20-odd years than anybody realized.

Of more immediate urgency, the government has been paying out much more in benefits, and collecting less in taxes, than was necessary to protect citizens against inflation. Switching to a more accurate measure would take the U.S. a long way toward balancing the budget by 2002. The time would seem propitious for such a move, with a safely re-elected President facing a Congress dominated by Republican budget hawks, and both seeking ways to slow the growth of spending on entitlements such as Medicare and Social Security before a real crisis breaks.

To the Clinton Administration and congressional powers, however, the news from the commission seemed too true to be good. Changing the way inflation is measured would mean telling Social Security pensioners and veterans that their benefit checks won’t rise as fast as they have expected. And telling some millions of union workers that their future pay raises may be smaller. And telling some 160 million taxpayers they will eventually have to hand over more to the Internal Revenue Service. Even telling members of the First Wives Club that their alimony and child-support payments will increase less rapidly.

What Congress member or Administration official dares inform these people that for years they have been getting more than they deserved? “Everyone right now is standing like the scarecrow in The Wizard of Oz, pointing in both directions and looking to see who goes first,” says Ari Fleischer, spokesman for the House Ways and Means Committee. “Clearly this reform will not be successful without President Clinton’s leadership,” says William Roth, chairman of the Senate Finance Committee. Clinton, however, has only asked his economic team to evaluate the report of that panel, which was headed by Michael Boskin of the Hoover Institution.

So rejiggering the CPI might be put aside for scholarly debate and perhaps glacial, piecemeal action–unless it becomes the last resort for producing a balanced budget. That could happen. Says New York Democratic Senator Daniel Patrick Moynihan: “The seven-year balanced-budget plan of the President says in the final years there’s a 30% unspecified cut in discretionary, nondefense spending. Without [the CPI change] you couldn’t do that.” But even then Republicans and Democrats, Congress and the President, would all have to agree to join hands and jump together.

It’s true that a credible plan for balancing the budget might lead to lower interest rates, helping anybody who borrows to buy a car or house. Fannie Mae estimates families might save $100 a month on each $100,000 borrowed. A strong case could be made, too, that adopting the recommendations of the Boskin Commission would spread the pain of balancing the budget as widely and mildly as possible. The elderly would still have their Social Security pensions raised next year, though by an average $13 a month rather than $21. A median family of four would pay $37 in extra taxes the first year, according to the accounting firm Coopers & Lybrand.

Fundamentally, though, the argument is simply that the CPI needs fixing to reflect reality. Explanations are often couched in arcane jargon, but the principles ought to ring a bell with anyone who kicks at a tire or wheels a cart through a food store.

To construct the CPI the Bureau of Labor Statistics checks the prices of a “market basket” of some 90,000 products and services–everything from a half-gallon carton of milk to the daily rate of a hospital room. They are given weights that are supposed to represent a typical family’s buying patterns–so much for food, so much for movie tickets, so much for auto insurance. But the current market basket represents buying patterns in the years 1982-84, not those of today.

The Boskin Commission makes three major criticisms of the index:

1) It does not reflect quality improvements adequately. If radial tires last three to five times longer than the bias-ply tires they replaced, their price could go up in dollars but drop per mile driven. But the CPI reflects this only partly, if at all.

2) It does not take account of how price increases change consumer behavior. For example, when the price of asparagus rises sharply, shoppers may buy cheaper broccoli instead.

3) It prices the same products in the same stores at regular intervals. Thus it does not reflect the way consumers take advantage of weekend sales, buy at lower prices from catalogs and shift from neighborhood stores to big barns selling everything from tube socks to ridable snow blowers at discount prices.

Boskin and colleagues figure the real cost of living in 1996 rose only about 1.8% rather than the 2.9% CPI increase that next year’s Social Security pensions will be based on. That may seem small, but spread over trillions of dollars in government spending–about a third of which is increased in tandem with the CPI–and compounded over the years, it adds up.

About 94 million people receive government benefits–Social Security and federal-worker pensions, veterans’ benefits, food stamps, subsidized school lunches–that by law are tied to the CPI. Perhaps 3 million workers have union contracts linking future wage increases partly to the index. Taxpayers’ personal exemptions, standard deductions and tax-rate brackets are adjusted each year in tandem with the CPI, and the cumulative effect of changing those adjustments could be huge. The extra $37 paid by a median family the first year would grow to $1,755 over 10 years.

Moynihan and others argue that pensioners, union members and taxpayers would still be protected against real, rather than phantom, inflation. But try telling that to the pensioner who hears from the American Association of Retired Persons that if Boskin’s figures rather than the CPI are used, the difference in her pension would grow to $1,296 annually in 10 years and to almost $20,000 after 19 years.

Apart from budget policy, though, the Boskin report could solve some nagging mysteries of the economy. How could Americans increase enormously their consumption of everything imaginable if wages have been lagging behind prices since 1973? Answer: that wage lag is a myth, created by inaccurate measures of inflation. And why have gains in productivity been so meager lately despite much anecdotal evidence that the gains should be quickening? Answer: overstating inflation leads to understating productivity. The upshot: rather than reining in the economy lest too fast growth lead to a ruinous price spiral, Federal managers would be well advised to relax and let the good times roll.

–Reported by James Carney and John F. Dickerson/Washington and Susanne Washburn/New York