THE ONE PERCENT SOLUTION?

Monday, February 24, 1997

Hoover fellows Michael Boskin and David Brady discuss why it's important to adjust the CPI now and whether it's politically possible to do so.

Recorded on Monday, February 24, 1997

ROBINSON: Welcome to Uncommon Knowledge. I'm Peter Robinson, a fellow at the Hoover Institution. Our show today, the consumer price index, but don't touch that dial, it is not a technical as it sounds. Watch this. Sausage links, bikini, hedge trimmers. What do these items have in common? Every month some 200 workers from the Bureau of Labor Statistics in Washington fan out across the country checking the prices on these and some 90,000 other items. Why? To put together the Consumer Price Index or CPI. Now here's the twist. The CPI is used as a measure of increases in the cost of living or inflation, but evidence has been mounting for many years that the CPI overstates inflation. Now, there are several ways in which the CPI does so, but just to give you one example the CPI uses a market basket, a selection of goods that was chosen in the early 1980's. Some things haven't changed at all. A rainbow trout is still a rainbow trout. But whereas in the 1980's we were using these, today a lot of us are using these, and whereas in the 1980's we were placing our calls on the Princess-line phone today a lot of us are using the beam-me-up-Scotty cellular phone instead. The CPI doesn't catch these changes in everyday technology. One of our guests today is a leading expert on this issue, economist Michael Boskin, a fellow at the Hoover Institution, recently led the congressionally appointed Boskin Commission which recommended changes in the Consumer Price Index. David Brady, a political scientist at Stanford and also a Hoover fellow, will talk about the politics of trying to change the CPI. We began by talking about the Boskin Commission's principle finding: that the CPI overstates inflation by about 1.1 percent.

CORPULENT PRICE INDEX
ROBINSON: What are the mistakes that the Bureau of Labor Statistics makes in compiling the CPI today?

BOSKIN: Now I don't really much like the term "mistakes," but they use certain procedures that could be improved and I think there are two broad classes, and they themselves have recognized this and have tried to make improvements over time, some of which have been very good but they I think can move at a faster pace and do more given what we've learned in economics research and in the government hand in the private sector. The first class of issues is really accurately reflecting what people are buying in the marketplace, where they are buying it, and when they are buying it. The current Consumer Price Index uses a fixed market basket of goods based on a survey of households from the early 1980's, so all of you out there think about what you've bought in the last month or the last year, what products or services you are using, many of them didn't exist in the early 1980's, many of them have had their quality improved, and you shifted around depending on what has happened to the prices and services. If the price of something goes up much more rapidly much more rapidly than something, than a close substitute, if the price of Delicious apples goes up you will buy Granny Smith apples. If the price of hamburger goes up you might buy chicken parts for dinner or something of that sort. And it is - the CPI is constructed as if consumers don't adjust at all. It kind of ignores that behavior that allows households in America or anywhere partially, only partially, to insulate themselves from part of the price increase. There are better off than if they were forced that if the price of hamburger goes up they are better off than if they were forced to continue buying the hamburger if they have another alternative that didn't go up as much. The second thing is that there are new choices. Things improve in quality, new products come along and the CPI gets them in very late. Cellular telephone service is not in the Consumer Price Index yet even though there are 42 million cellular phones and 100 million receive telephone calls on land-line phones placed on cellular phones. VCR's, personal computers, microwave ovens all got into the index 10 or 15 years after they were introduced and after their price fell a lot and their quality improved a lot. So they show up kind of in pretty good shape at low prices in close to their final form and they get tracked from then on and we miss all the price decline and the typical product cycle of most goods, especially durable goods.

ROBINSON: Okay, and so let me see if I have got this. It gets complicated but the basic point remains. As a measure of increases in the cost of living the CPI is wrong.

SO?
ROBINSON: The Boskin Commission studies the matter and concludes that the CPI overstates inflation by about one percent a year: who cares, why is that important?

BOSKIN: Well it is enormously important for many things, Peter, but there are two major reasons, two categories. One is the prices of goods and services are the basic building block of all the information we have on the economy. It is the building block of how we measure GDP - the total value of goods and services, Gross Domestic Product, how we measure economic growth over time. We have to separate out having more goods and newer and better goods and services than from price increase so when you hear people say "real GDP" or "real wages" or "real median income" that means we are taking the money measure in a recent year, say 1997, and we are adjusting it for a measure of inflation to compare it with the same yardstick to get in the same units constant dollars in 1987 or 1997 or 1957. And to do that properly means you need a good measure of the change in the cost of living and of inflation and it you don't do that very well, if it is off, especially if you make comparisons over a long span of time - a decade or two or more - or among countries you can totally miss how we're doing. The second big issue, in addition to having accurate information to our citizens, accurate information to our policy makers, the Federal Reserve to do monetary policy or whatever is that we have a huge number or programs that are automatically adjusted every year by the change in the cost of living as measured by the Consumer Price Index. The intent of indexing one-third of budgetary outlays and part of the tax code was to insulate the taxpayers and the beneficiaries from changes in the cost of living and we have been overdoing that.

ROBINSON: Name a couple of those programs.

BOSKIN: Social Security, other retirement programs, supplemental security income, the tax brackets that were done in the 80's, Social Security was done in the mid-70's and this has a very pronounced effect. In fact, leaving aside the fact that we probably over-index from the standpoint of just compensating people for inflation - now you may have a view that the structure of the program is such that we want higher benefits for some people, lower for others - that is a separate issue. But just in the purely technical terms of are we accurately compensating people for inflation no more no less we have clearly been overdoing it. And that implies huge future budgetary outlays above and beyond what was original congressional attempt. For example, over the next dozen years we will add $1.1 trillion to the national debt if we continue adjusting with the CPI if it continues to overstate by 1.1 percentage point. Within 10 years just the overstatement will be the fourth largest federal government program after Social Security, health care and defense. This error, this mistake, this unintended over-adjustment will become the fourth largest spending program in the federal budget.

ROBINSON: Okay, now if that is true, if we could save the federal government billions just by making a dinky, little statistical correction then why don't we just do it?

SHOUDA, WOULDA, COULDA...
ROBINSON: David, you are a political scientist. This will be easy, right? Trent Lott and Newt Gingrich and the President ought to be able to agree and just push this legislation right through.

BRADY: Now we move from the sensible to the..

ROBINSON: What we are moving here from is what ought to be done, to what could be done, can be done.

BRADY: The question is what is the time frame in which this might occur? I don't think it is going to happen in this Congress.

ROBINSON: How come?

BRADY: First of all, who is going to lead it? I think the Republicans got burned very badly on the Social Security issue and the whole issue of the nastiness issue by President Clinton so they are going to have to have the President take the first step. And my read of President Clinton's budget is that it really isn't a very good budget for reducing the deficit. Not only does it back-load things way down the line but the second thing is if you actually look at his first year out, if you take the Oklahoma Land Sale and the Spectrum Sales away, it is actually an increase over the last year's budget. So..

ROBINSON: Increase in the deficit?

BRADY: No, it is actually, he's got some income coming in from sales..

ROBINSON: Oh, sorry.

BRADY: So actually, there is not real cuts that he - that the proposal is so this budget starts out this year and we are cutting $12 billion - it is not there at all. There aren't any cuts. I think that it is not really a - I don't see any courage there in leading the battle to really bring about some cuts.

ROBINSON: Now why is courage needed? Whose fingers will be burned if this very sensible adjustment gets made?

BRADY: Whose fingers will be burned?

ROBINSON: That is right.

BRADY: It will be portrayed - imagine you are a congressman or a congresswoman and you are from a moderate district or you have a lot of elderly people in the district and the same thing the thing you are worried about is, gee, come 1998 what will happen? Well I voted to do this to the Consumer Price Index. It is going to be portrayed or is potentially portrayed unless members are provided cover it can easily be portrayed as you were out to get old people because at some point Social Security will be lower because that is what it's about. And if you are going to get an opponent then. So remember in 1982 when President Reagan had to raise taxes after the '81 tax cut, he and the Democrats got him to move first and they got him to provide cover by actually submitting a letter and saying if you vote for this I won't. So the President has to at least provide cover, to make it appear to be bipartisan in the short run. I don't see any evidence that the President's going to lead on that.

ROBINSON: Mike, you are not only an economist you are a practical politician. You served in the Bush Administration, you know plenty about Washington. Listen to this sentence by the Executive Director of AARP, the American Association of Retired Persons, one sentence. "The recommendation of the Advisory Commission headed by Michael J. Boskin to reduce the Consumer Price Index by 1.1 percent would result in a tax increase and a Social Security cut." Now them's fightin' words. As a practical matter, how do you see this happening?

BOSKIN: Obviously there are people who will attack this as against the short-run interests of the people they claim to be representing. I personally think it is very short sighted. I think Social Security has much worse longer-run problems and if we don't do something gradual and modest and sensible and phased-in like this, the people, these people they purport to represent will be much worse off down the road. But the opportunity is quite ripe for demagoguery here and David is quite right that this has to happen as a bipartisan effort with cover provided..

ROBINSON: Let me try an argument that is also made by AARP, the American Association of Retired Persons. They won't admit necessarily that the CPI does overstate inflation but even if it does consider the basket of goods that older Americans have to buy. A very large part of their basket is medical care, and medical care has been rising faster - there is very little dispute that medical care has in fact been rising at quite a clip - faster than whatever rate of inflation you care to assess. Is there some validity to that?

BOSKIN: Well, less than meets the eye. It is true that medical costs have been going up more rapidly than the average of other products. It is also that one of the biggest defects of the CPI is most glaring in medical care which is the inadequate adjustment for quality improvements which is endemic in medical care.

ROBINSON: Would you give me an example? For example..

BOSKIN: Suppose you have drugs replacing surgery or arterioscopic surgery replacing invasive surgery, that may show up as a price increase in the consumer price index because the surgery is more expensive but it saves you a year of rehab, you get back to work, you are out of the hospital in a couple of days rather than a week, you're etc. So if you think of the episode as what we have been able to accomplish in improving the quality of care there is unanimity in people who study this that a large part of what the CPI calls medical inflation is quality improvements. There is a separate issue whether in our Medicare systems and in our health insurance system we want people to be spending more on quality and so on and whether they ought to have more choices, but the fact of the matter is if you actually try to do a separate price index for the elderly it turns out to look virtually identical to the..

ROBINSON: It does.

BOSKIN: Virtually identical to the price index for the general population.

ROBINSON: So that is a very direct refutation of this point.

BOSKIN: Yes. This point is just incorrect.

ROBINSON: Okay. So..

BOSKIN: I mean it is correct that they spend more..

ROBINSON: Even though Mike refutes the AARP's argument as just plain wrong, I have a feeling a Washington politician would ignore the AARP at his peril.

WATCH IT THERE, SONNY
ROBINSON: I'm 80 years old, the value of my home may be going up, I may have a prospect of living to 90 whereas a decade or a decade and a half ago my prospect might have been to live to 82, but I still have very expensive medical bills and I just have to meet the cash obligations that are coming down on me. So..

BOSKIN: So those are taken care of by Medicare or subsidized in other ways. Some are indeed increases in the cost of living of the elderly, who by the way have in addition to Social Security a variety of other programs that support them, however, there are many other expenses that younger or middle-aged people have that the elderly do not. You can't just take one good out of market basket and say you know this is terrible, this is going up and therefore I am in worse shape than the average because they are also spending less for example on college tuition.

ROBINSON: Right. Okay.

BRADY: Mike is exactly right on that. The economics of it is exactly right. You can't pick and choose. The politics of it is they do pick and choose. You should remember about the AARP that that is the organization that in the early 80's insisted to the Congress that they have catastrophic health insurance because their membership wanted it and then of course it turned out Congress passed it. Suddenly the members, the people went, "Oh! You mean we have to pay for this?" So Congress had to turn around and reverse it. So I do want to say that I do hope that Mike is right, that there is when it comes time at the budget deal one hopes that reasonable people and I think that reasonable people in both parties can be on the side of this - this is sort of a center out coalition. What I worry about is to what extent the Left and the Democratic Party is willing to demagogue this issue and let me just give one other example of that even those it is on the Balanced Budget Amendment. The, as Mike knows better than I do they have done a Unified Budget since 1969..

ROBINSON: Hold on. You explain these terms "unified budget"..

BRADY: Oh "Unified Budget" just means that the Social Security trust fund and Medicare that those are included in looking at the Balanced Budget. So the Balanced Budget Amendment includes the Social Security trust funds. So this time the Democrats bring up the issue - some Democrats bring up the issue of we're in favor of the Balanced Budget Amendment but we've got to protect Social Security. So knowing full well that that has not been - that the Unified Budget has been there since 1969 and all the years in which they had Democratic Presidents and some of the very members that are now - its a ruse, its false, but it is being used and it is going to work. It is going to work because senators are going to say, "I don't want to take on Social Security."

ROBINSON: So this kind of demagoguery is about to defeat the Balanced Budget Amendment to the Constitution. You think, you'd predict?

BRADY: That is what I think will happen. Yes.

ROBINSON: And it is exactly that same kind of a Democratic - do you both agree here that the main threat is from the Left of the Democratic Party?

BOSKIN: Well, I am trying to be nonpartisan. People say, "Was your commission bipartisan?" Actually a majority of the members were Democrats and so it was nonpartisan. We were technically economists as the first external expert review of the nation's price statistics in 35 years since the Stigler Commission named after the late George Stigler, a Nobel Prize winner and Hoover senior fellow from University of Chicago examined this many years ago. But there to the extent that it is going to be demagoged, perhaps that is the most likely place. There are people from many different quarters who either don't understand this or who have different fish to fry or want to get it caught up in their own agenda, want to use it for other purposes. I don't know if its kept as an accuracy technical adjustment to try to get more accuracy. I think the odds are reasonable. They are certainly not overwhelming but there are reasonable that Congress will do something.

BRADY: First of all when I said I think it is going to come from the Left I think that that is certainly is factually true independent of my views. They are going to do the more complaining about it because they view Social Security as a social compact and for them they see it as this of our commitment to ourselves and not as a technical issue. So they will fight it. And the second way..

ROBINSON: They see it as a basic issue about American life and how we treat..

BRADY: Yeah, exactly. How we treat each other and so on and so forth.

ROBINSON: Is there a stronger defender of Social Security in the United State Congress than Pat Moynihan from New York, Democratic senator from New York? You can't find one.

BOSKIN: I think that is probably right.

ROBINSON: Okay. He is the strongest supporter in the Congress..

BRADY: Absolutely.

ROBINSON: On this issue. How come? Safe seat or a nobler mind?

BRADY: No there is two..let's think of the sources. First of all you may get some sources of opposition from ideological left just like you may get it from the ideological right on other issues so that is not a partisan statement. The second source is..

ROBINSON: By the way, there would are some on the right who would say this is a tax increase.

BRADY: Absolutely.

ROBINSON: So in that light it is somewhat symmetric.

BRADY: So in that sense you may get the..

ROBINSON: It's wrong. It's an elimination of an automatic real tax cut that occurs surreptitiously in the budget.

BRADY: I agree with you.

ROBINSON: Okay.

BRADY: And the second source which is the one Mike also pointed out is just having a lack of information. And that is there is lots of people who have no idea what goes on in the budget or these are reasonable complicated issues so as soon as you go to the Unified Budget what does that mean or what does the CPI mean and needless to say in a situation like that members, given that there is uncertainty and the electorate doesn't have much information, members are mainly concerned about how will this change effect me and what they worry about then is not just it's a technical change, they have to defend it and they also have to, in addition to defending it, they have to worry about how could this issue be used against me? So the best strategy for passing it is it seems to me to continue to push, as Mike is talking about, the technical aspects of it, to continue to build it that it is Moynihan, its Mack, it's a center-out coalition that will hopefully be able to cut some sort of deal. So I am not saying it can't be done. I am saying it is going to be very - its hard to do - the President would be a big player in this and he has..

ROBINSON: Can it happen in this Administration?

BRADY: Well, I would think that you certainly would be able to make an intelligent argument to the President saying, "Look, this is a technical problem. What you are doing and what you have been doing is a) increasing benefits to certain people and other people are paying lower taxes and the notion is as the Commission is pointed out or some variation of it would be best for all concerned. And I think Mike is absolutely right on that. You have got to continue to push that view. How the President will react to that, eh, I don't know. I am not on intimate terms.

BOSKIN: I think it is very early to tell who is going to be doing what and whether something will be done, however, from the Administration there has certainly not been aggressive leadership but there has been - there has certainly been a receptivity and it may be somewhat cautious..

ROBINSON: Did you hear from Secretary Rubin or...

BOSKIN: Well, I think that Secretary Rubin has been very explicit, Secretary of the Treasury, the President has said that we will have to see what the experts say, Secretary Rubin said we have to get a consensus of experts, Maurice and Lee having seen what other people are saying, many of whom are saying actually our numbers drop the most the best technical experts are mostly saying that we are probably a little low even in our estimate and we did a very careful job, but Secretary Rubin has been - you know he hasn't gotten way ahead of the President or anything - but he has said, "Look, it does look like there is a consensus among the experts."

ROBINSON: They let you do it. They didn't slam you down?

BOSKIN: Not in the least.

ROBINSON: Okay.

BOSKIN: And they deserve credit for that. Obviously, as David pointed out, it is a very sensitive political issue and I don't think we should be pushing anybody who is trying to see what can be done. They are going to need some maximum amount of flexibility without getting into a hardened position.

ROBINSON: So, you try to adjust the Consumer Price Index and what do you get? Hits from older Americans, hits from the Left, hits from the Right. It's a mess.

IS THIS ANY WAY TO RUN A COUNTRY?
ROBINSON: Isn't this one more case of a kind of permanent problem in Washington of interest group politics, that is to say that the beneficiaries of government largesse have an incentive to be well organized, to spend money fighting for their position through the political system, whereas the beneficiaries or those who represent the national interest in this, that is to say people who would benefit over longer term by a lower budget, savings in the budget, so on, have a - face virtually no incentive at all to inform themselves to fight for the position. How do you a) do you agree that this represents one more case of a kind of classic interest group problem?

BRADY: No.

ROBINSON: You don't. Why not?

BRADY: Because interest group politics has always been present from Madison's Federal's Paper 10 and 51, it is inherent in the name of the game. There is always interest. What I like is the way usually if it is on my side I am for the common good, but your interest is self-interest. I think it is perfectly normal for interests to take these sorts of positions and the question is in this case - it is the case - Mike's commission and the work is on the Right side over the long haul but that doesn't mean that I think the process is going to be decided by some plutonic cards man. We decide these things in democratic small "d" democratic countries on the basis of you take positions, you write papers, you have people like Mike Boskin do the commission and they continue to make these arguments and then you win a majority. That is the name of the game. But you can't pull interest groups out of that process.

ROBINSON: If we continue to systematically in a widespread way substantially over-adjust for the cost of living in the federal budget, we are going to be adding a huge amount of additional debt. Who is going to pay that?

BOSKIN: The Baby Boomers. The Baby Boomers children, their children, children not yet born. We already have put a large burden on future generations and we ought to be trying to anticipate this demographic tsunami of the Baby Boomers' retirement with a sensible, gradual, cautious, phase-in approach to getting this under control and a CPI adjustment can be one part of that. And I strongly believe we should be doing an adjustment of this sort whether or not we had a budget deficit now or between now and 2002, and whether or not we had long-run entitlement cost problems. We should do it because the purpose is to be accurate and to compensate people and insulate people for inflation, to get the program spending and the tax code running right we ought to get a more accurate measure. We also owe it to our citizens to give them an accurate idea of where we are, where we are going and where we have been.

BRADY: I think that the power of those arguments - I actually believe that the power of arguments over time makes a difference. We are talking about it now, we weren't talking about it 5 years ago and the facts are that it will succeed. I am not sure it is going to do it in this Congress, but within 5 years, basically the broad outlines of the commission will in fact have been enacted.

ROBINSON: Dr. David Brady, Dr. Michael Boskin, thank you very much.

BOSKIN: You're welcome. Our pleasure.

ROBINSON: Fishes and phones. Things that don't change and things that do. As our guests explained today, the statisticians have no problem at all with one of these but with the other they need to work a little harder. I'm Peter Robinson. Thanks for joining us.


This program was funded in part by a grant from the Starr Foundation.