Recalculating inflation: billions in savings for governments and employers paid for by workers and pensioners
At that time, I suspected changes to calculations of the CPI would be introduced as part of the renewal of the inflation target with the Bank of Canada, and they were clearly planning it at the time, but wanted to keep it under wraps.
While these changes may seem like obscure “refinements”, they could eventually lead to billions of dollars in lower payments from the federal and provincial government in Old Age Security Payments alone, billions in higher personal income tax revenues, and even higher savings from all employers from lower wage increases implicitly tied to CPI increases.
These savings for governments and employers of course won’t come out of thin air, but will be paid for by workers, pensioners, other income earners and income tax payers. For instance, a change that reduces the measured rate of CPI by 0.6% a year would mean a cumulative loss of $18,000 in income over ten years for someone with a starting salary of $50,000 with wage increases tied to inflation — not even including the impact of higher taxes and lower social transfers.
While there are some legitimate arguments for why the CPI overstates the real rate of inflation, there are also many reasons why the CPI understates the real changes in the cost of living — but these very well may be ignored by those making these changes, as they were largely ignored in the U.S. 1996 Boskin Commission.
For instance Canada’s CPI uses a new house price index for housing costs, which has increased at half the rate of resale homes. It also doesn’t account for faster depreciation and technological obsolescence of most goods, such as computers and cell phones. Nor does it account for increased commuting times, reduced public services, increased environmental costs or quality of life factors. All these factors affect the real cost of living for Canadians and they too should be accounted for in any revisions to any inflation or cost of living index as important as the CPI.
At the very least, the federal government should refer this issue to a public commission, as the United States Senate did in 1996 with the Boskin Commission, instead of unilaterally devising changes that will have such a large impact in secret behind closed doors.
Here’s the relevant text from the piece I wrote a year ago (pp. 9-10 in CUPE’s March 2011 Economic Climate for Bargaining)
Redefining inflation: who wins and who loses?
There’s another more obscure technical change that could lead to very significant impacts without even changing the inflation target.
This involves changing how inflation is measured. It may seem arcane, but it could ultimately lead to billions a year in losses for workers and pensioners, and billions in annual gains for governments and employers.
It has happened before. The 1996 Boskin Commission decided the US Consumer Price Index (CPI) overstated inflation by 1.1 percentage points a year mostly because it didn’t adequately account for the impacts of people shopping around for better deals. The changes to the U.S. CPI implemented since then saved the U.S. government hundreds of billions a year through lower social security payments and higher tax revenues.
By reducing the measured rate of inflation, they also reduced wage increases for most workers. Although the changes may seem small in any one year, they keep on growing cumulatively.
The Canadian government has also made more minor changes to reduce the way Canada’s CPI is measured, sometimes with little or no public notice. Now there is speculation the federal government may change the way the CPI is measured so that the official rate would be about 0.6 percentage points lower every year. It is important to understand this wouldn’t have any direct real impact on prices or inflation, but it would have very real consequences for wages, incomes, transfers and taxes that are linked to this measure of inflation.
A 0.6% annual reduction might not seem like a lot, but it really adds up and would mean major gains for federal and provincial governments paid for by workers, pensioners and other income earners. After ten years, a 0.6% annual decline would result in 6% lower wage, pension or transfer income. The cumulative loss over those ten years works out to over 30% of annual income, e.g: over $18,000 for a starting income of $50,000. The chart on the following page illustrates how these annual losses would grow over time.
Then on the flip side, workers would also end up paying more of their income in taxes because the tax brackets and credits would rise at a lower rate. The basic personal income tax credit would also end up being 6% lower in ten years time and taxes would be commensurately higher.
The major beneficiaries of this change would be governments through lower transfers and higher taxes and employers, through lower wages. The savings for them would be very significant and rapidly cumulate over time.
For instance, the annual savings to the federal government from lowering Old Age Security payments by 0.6% a year would rise from $210 million in the first year to over $1.2 billion in year five and almost $3 billion a year in ten years.
The increased revenues for the federal government just from a 0.6% lower annual increase in the basic personal income tax credit are of a similar magnitude: $180 million in the first year, rising to over $1 billion a year in year five and over $2.5 billion a year in ten years.
There are some legitimate arguments for why the Consumer Price Index may overstate the real rate of inflation and certainly better measures of inflation should be welcomed. However, there are also many reasons for why Canada’s CPI understates real changes in the cost of living but these appear to be ignored by those advocating for these changes.
For instance, Canada’s CPI uses a new house price index for housing costs, which has increased at half the rate of resale homes. It also doesn’t account for faster depreciation and technological obsolescence of most goods, such as computers and cell phones. Nor does it account for increased commuting times, reduced public services, increased environmental costs or quality of life factors. All these factors affect the real cost of living for Canadians and they too should be accounted for in any revisions to any inflation or cost of living index as important as the CPI.
Update (14/2/12): The Globe published a piece I wrote on this in their Economy Lab section today.
The Star also published an article on this issue, interviewing Susan Eng of the Canadian Association of Retired Persons (CARP) and Erin Weir, a frequent contributor to this blog. (However, I don’t think the TStar article is accurate in saying that in the U.S. inflation is thought to be overstated by as much as 1 percentage point.)