Adjusting the Consumer Price Index.

• Author: Schnepper, Jeff A.

The Consumer price index (CPI) is our national inflation gauge. It is supposed to represent the impact of changes in prices over a period of time. It is used to adjust benefits, such as Social Security, and taxes. It also is wrong!

Every month, the Bureau of Labor Statistics sends out about 400 data collectors to record roughly 80,000 prices of everything from meat to college tuition. Cemetery lots, tax preparation fees, and about 100 new car models regularly are priced. The idea is to replicate a "market basket" of goods and services purchased by typical American consumers. Individual prices are weighted in the index according to their importance in people's buying habits.

Unfortunately for accuracy's sake, this market basket is updated just once a decade, based upon a huge survey of people's spending. However, buying patterns change constantly. Ten years ago, relatively few had video cassette recorders (VCRs) or personal computers. Today, millions have both. As the cost of renting video cassettes decreases and the cost of going to the movies increases, people will rent more. Because the CPI is revised only periodically, these changes will be understated, and the index itself will be in error.

New products clearly skew the index. I bought one of the original electronic pocket calculators in 1970 for $400. Today, I can get a smaller model that does twice as much for less than $10. Microwave ovens were first included in the index in 1978; VCRs and personal computers did not show up until 1987. Moreover, improvements in quality are ignored. Current models of refrigerators use less electricity and new drugs replace surgery. The index misses both changes.

Recently, a panel of five prominent economists, chaired by Michael Boskin of Stanford University, concluded that inflation, as measured by the CPI, is overstated by a full percentage point, or even two. The implications of such an overstatement are enormous.

The CPI is used to adjust government benefits (mainly Social Security) and taxes-specifically, the personal exemption, standard deduction, and tax brackets. For instance, the government has announced that Social Security benefits for 1996 will rise 2.6% because the CPI increased by 2.6% over the last year. The above tax adjustments also will be modified by 2.6% (appropriately rounded) so that inflation will not erode benefits or increase taxes. An overstatement of the index can be devastating to the budget; a correction to the index can be...