Comparing traditional and chained CPI

Question:   What is the expected value of lifetime Social Security benefits for females and for males when benefits are linked to the traditional CPI and when benefits are linked to the chained CPI.

Discuss the reasons why women might prefer a switch to the chained CPI over proposals to partially privatize Social Security.

Short Answer:

Answer is contingent on several assumptions laid out below.  I find that changing from the traditional CPI to a chained CPI would reduce the expected value of lifetime Social Security benefits by around $16,000 for males and $21,000 for females.

The actual impact is invariably different from the expected impact.  Regardless of gender, people with the longest life span get the most from Social Security.

However, Social Security is really essential for females because private annuities are more expensive.  See my previous post on this topic.

http://dailymathproblem.blogspot.com/2014/01/gender-differences-in-life-expectancy.html

Analysis:

Key assumptions:

The key assumptions in this analysis are

  1. Person retires at age 62 and receives an initial Social Security retirement benefit of $15,000 per year
  2. Traditional CPI grows at 2.42% per year
  3. Chained CPI grows at 2.09% per year.
  4. In year of death person receives ½ year Social Security Benefit
  5. Probability of surviving from age 62 to age y> 62 is determined by the CDC life tables for females and males.

Readers interested in the discussion of assumptions on difference between traditional and chained CPI might want to look at this post.

http://dailymathproblem.blogspot.com/2014/02/comparing-traditional-and-chained-cpi.html

The expected lifetime Social Security benefit is E(SSB)=Sum(Pyr x CByr)  where Pyr is the probability of surviving to a particular year and CByr is the cumulative benefit from the retirement age at 62 to the year of death.

The logic behind the calculation of the probability a retiree survives to a specific date is similar to the logic behind the geometric distribution.   The probability of surviving to age y > 62 is the product of the probability of surviving to age y-1 and the probability of dying at age y.

Calculations:

The chart below has data on likelihood of surviving to age y+0.5 for males and females and the cumulative Social Security Benefit to age y+0.5 under both the existing COLA and a chained CPI COLA.

Survivor Probabilities and Cumulative Benefits
Age y Probability of surviving to exactly age y+0.5 for males Probability of surviving to exactly age y+0.5 for females Cumulative Benefit With Existing COLA Cumulative Benefit With COLA linked to chained CPI
62 0.01321 0.00831 $7,500 $7,500
63 0.01405 0.00896 $22,682 $22,657
64 0.01496 0.00965 $38,230 $38,130
65 0.01599 0.01044 $54,156 $53,927
66 0.01713 0.01133 $70,466 $70,054
67 0.01830 0.01227 $87,171 $86,518
68 0.01946 0.01322 $104,281 $103,327
69 0.02062 0.01422 $121,805 $120,486
70 0.02178 0.01526 $139,752 $138,004
71 0.02306 0.01647 $158,134 $155,889
72 0.02458 0.01783 $176,961 $174,147
73 0.02620 0.01929 $196,244 $192,786
74 0.02780 0.02077 $215,993 $211,816
75 0.02935 0.02224 $236,220 $231,243
76 0.03079 0.02380 $256,936 $251,076
77 0.03230 0.02547 $278,154 $271,323
78 0.03392 0.02732 $299,885 $291,994
79 0.03557 0.02926 $322,143 $313,096
80 0.03691 0.03112 $344,938 $334,640
81 0.03791 0.03288 $368,286 $356,634
82 0.03876 0.03473 $392,198 $379,088
83 0.03954 0.03677 $416,690 $402,011
84 0.03996 0.03858 $441,774 $425,413
85 0.04032 0.04017 $467,464 $449,304
86 0.04010 0.04170 $493,777 $473,694
87 0.03929 0.04275 $520,727 $498,594
88 0.03787 0.04322 $548,328 $524,015
89 0.03584 0.04302 $576,598 $549,967
90 0.03325 0.04209 $605,551 $576,461
91 0.03021 0.04041 $635,206 $603,509
92 0.02681 0.03798 $665,578 $631,123
93 0.02321 0.03490 $696,685 $659,313
94 0.01957 0.03128 $728,544 $688,093
95 0.01604 0.02730 $761,175 $717,474
96 0.01276 0.02314 $794,596 $747,469
97 0.00984 0.01903 $828,825 $778,091
98 0.00734 0.01513 $863,882 $809,353
99 0.00529 0.01163 $899,788 $841,269
100 0.01012 0.02606 $936,563 $873,851
1.00000 1.00000

The expected value of lifetime benefits for males/females under traditional/chained CPI is simply the dot product (the sum product function in EXCEL or NUMBERS) for the relevant probabilities and cumulative benefits.

Impact of Change in COLA by Gender
Males Females Difference Females- Males
Traditional CPI $392,077 $463,804 $71,727
Chained CPI $376,005 $442,772 $66,767
Difference Traditional-Chained CPI $16,072 $21,032

The change in the COLA formula from the traditional CPI to the chained CPI leads to a reduction in expected lifetime benefits of $16,000 for males and $21,000 for females.

Social Security still provides longevity protection under a chained CPI.

http://dailymathproblem.blogspot.com/2014/01/gender-differences-in-life-expectancy.html

This is especially important for females because of their longer life expectancy.

Concluding Thoughts:

The issue of the Social Security COLA is important and complex.   I am of the view that a change in the COLA could be part of a package of Social Security and retirement reforms.  Social Security reform must also encompass additional revenues and rule changes that eliminate future automatic cuts in Social Security benefits.   Pension reform must encompass improvements t0 401(k) plans and additional sources of low-cost annuity income.

Some readers might be interested in my views on the politics of the COLA debate.

http://policymemos.blogspot.com/2014/01/common-ground-on-social-security-colas.html

Impacts of shift from traditional to chained CPI on Social Security Benefits

Question: What is the potential annual impact and cumulative dollar impact of a policy change that links Social Security benefits to the chained CPI rather than the traditional CPI?

Assumptions:

Analysis presented here pertains to a single retiree who retires at age 62 with a $1,250 per month Social Security retirement benefit.

The traditional CPI grows at 2.42% per year.  The chained CPI grows at 2.09% per year.     These statistics were based on BLS data over the 1999 to 2013 time period.  Economists at the Bureau of Labor Statistics at the Department of Labor informed me that they did not have data on the chained CPI for years prior to 1999.

See the link below for statistics on the traditional and chained CPI.

http://dailymathproblem.blogspot.com/2014/02/comparing-traditional-and-chained-cpi.html

Analysis:  Information on the growth of the annual Social Security Benefits adjusted for the traditional CPI and adjusted for the chained CPI is presented for a retirement potentially spanning from age 62 to age 100 is presented in the table below.

In this table, the first column is age, the second column is the Social Security benefit adjusted by the traditional CPI, the third column is the Social Security benefit adjusted for the chained CPI, and the fourth column is the cumulative change in the Social Security benefit due to the adjustment process.

Path of Social Security Benefit With adjustment based on the traditional CPI Path of Social Security Benefits with Adjustment based on the chained CPI Reduction in Benefits for Age Due to Switch from Traditional to Chained CPI Cumulative Reduction in Benefits
$15,000 $15,000 $0 $0
$15,363 $15,313.50 $50 $50
$15,735 $15,633.55 $101 $151
$16,116 $15,960.29 $155 $306
$16,506 $16,293.86 $212 $518
$16,905 $16,634.41 $271 $788
$17,314 $16,982.06 $332 $1,120
$17,733 $17,336.99 $396 $1,516
$18,162 $17,699.33 $463 $1,979
$18,602 $18,069.25 $533 $2,512
$19,052 $18,446.90 $605 $3,117
$19,513 $18,832.44 $681 $3,797
$19,985 $19,226.03 $759 $4,557
$20,469 $19,627.86 $841 $5,398
$20,964 $20,038.08 $926 $6,324
$21,472 $20,456.88 $1,015 $7,338
$21,991 $20,884.42 $1,107 $8,445
$22,523 $21,320.91 $1,202 $9,647
$23,068 $21,766.52 $1,302 $10,949
$23,627 $22,221.44 $1,405 $12,355
$24,198 $22,685.86 $1,513 $13,867
$24,784 $23,160.00 $1,624 $15,491
$25,384 $23,644.04 $1,740 $17,231
$25,998 $24,138.20 $1,860 $19,091
$26,627 $24,642.69 $1,985 $21,075
$27,272 $25,157.72 $2,114 $23,189
$27,932 $25,683.52 $2,248 $25,437
$28,608 $26,220.31 $2,387 $27,824
$29,300 $26,768.31 $2,532 $30,356
$30,009 $27,327.77 $2,681 $33,037
$30,735 $27,898.92 $2,836 $35,873
$31,479 $28,482.01 $2,997 $38,870
$32,241 $29,077.28 $3,163 $42,033
$33,021 $29,685.00 $3,336 $45,369
$33,820 $30,305.41 $3,515 $48,884
$34,638 $30,938.79 $3,700 $52,583
$35,477 $31,585.42 $3,891 $56,475
$36,335 $32,245.55 $4,090 $60,564
$37,215 $32,919.48 $4,295 $64,859

Some observations:

  • The annual impact of the change from the traditional to chained CPI grows over time.
  •  The annual impact is $463, at age 70 $1,302 at age 80 at age 80, $2,532 at age 90, and $4,294 at age 100.
  • The cumulative impact of the change in the COLA formula is $1,979 at age 70,  $10,949 at age 80, $30,356 age 90, and $64,859 at age 100.

Some Implications:

  • The change from a traditional to chained CPI would have a very large impact both on household and national finances.
  • The fiscal impact of the change in the COLA formula would grow for 38 years until it reaches a constant rate.   (After 38 years the new COLA fully impacts all retirees based on their age.)
  • The change phases in slowly which gives people time to respond and change spending patterns.
  • The annual and cumulative impacts are largest for people near the end of their life when expenses both from increased medical needs and a need to change living arrangements are largest.

You may be interested in my policy blog on the Social Security COLA.

http://policymemos.blogspot.com/2014/01/common-ground-on-social-security-colas.html

Unemployment, Labor Force Participation, and the Government Deficit

Unemployment, Labor Force Participation and the Government Deficit

Issue:   The Chart below has data on three important economic variables – the unemployment rate, the labor force participation rate and the government deficit as a percent of GDP.   The unemployment and labor force participation rate variables are observed on three dates   — July 2009 (near the peak of the recession) January 2017 (the month of President Trump’s inauguration), and September 2009 (the most recent month at the time of this writing.

What does this data say about the recovery after the recession under President Obama?

What does this data say about the impact of President Trump’s economic policies on the labor market and on the government deficit?

How does information from the unemployment rate and information obtained the labor force participation rate differ regarding, evaluations of the economic records for Obama and Trump, an assessment of the current strength of the economy and projections of the likely path of debt to GDP?

Three Economic Variables
Unemployment Rate
Date Value
Jul-09 9.5
Jan-17 4.8
Sep-18 3.7
Labor Force Part. Rate
Jul-09 65.5
Jan-17 62.9
Sep-18 62.7
Government Deficit as % GDP
Date Value
FY 2009 -9.8
FY 2016 -3.2
FY2018 -4.2

Trends:

The unemployment rate fell from 9.5 percent during the recession to 4.8 percent at the end of President Obama’s term.

The unemployment rate has continued to fall under President Trump and is currently at 3.7%.   This is the lowest level since 1969.

The labor force participation rate was higher during the recession than at the end of President Obama’s term.

The labor force participation rate has not risen under President Trump despite the tax cut.

 

The government deficit fell from 9.8 percent of GDP in 2009 (recession year) to 3.2 percent in 2016 (last Obama year.)

The FY 2018 deficit as a percent of GDP is 4.2 percent, substantially higher than when President Obama left office.

Discussion:

An analysis of economic conditions and the labor market based on the unemployment rate alone would conclude that the job market and economy are red hot.   The unemployment rate has not been this low since 1969.  President Trump’s tax cut is one reason why the unemployment rate fell to its current level.

An analysis of the recovery from the recession and current economic condition incorporating information about the labor force participation rate, indicates the economy is not over heated.

Many critics of President Obama claimed that recovery was weak because the labor force participation rate remained very low.

https://freebeacon.com/issues/obama-economy-9-9-million-employed-14-6-million-left-labor-force/

The labor force participation rate is lower under President Trump than under President Obama.   President Trump’s economic policies have failed to increase the labor force participation rate.

President Trump’s economic policies have increased the government deficit as a percent of GDP.  The 2018 fiscal deficit is over 30 percent higher than the 2016 fiscal deficit.

Concluding Thoughts:

My view is that the LFPR has decreased due to population aging and further stimulus will not expand the workforce.  Moreover, the decrease in unemployment which coincided with the tax cut will not persist for much longer.   The loss of revenues from the tax cut will be larger in FY 2019, 2020 and 2021.   The budget deficit could be larger than 9 percent of GDP prior to the start of the next recession.

President Trump by reducing taxes and expanding deficits in a strong economy has weakened the ability of fiscal authorities to stimulate the economy when the next recession hits.

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