ECONOMIC AND BUDGET ISSUE BRIEF

Using a Different Measure of Inflation for Indexing

Federal Programs and the Tax Code

Federal laws try to protect taxpayers and recipients of 

government benefits from the effects of rising prices by 

specifying that dollar amounts in many parts of the tax 

code and in some programs be automatically adjusted—

or indexed—for inflation. Without such indexing, a rise 

in the general level of prices would alter the effects of federal policies even in the absence of action by lawmakers. 

For example, if the dollar amounts that delineate the different tax brackets in the individual income tax were not 

indexed, inflation would push many people’s income into 

higher brackets and boost average tax rates over time, 

even if income did not grow faster than prices. 

Many federal programs and parts of the tax code are currently indexed to increases in the consumer price index 

(CPI), a measure of inflation calculated by the Bureau 

of Labor Statistics (BLS).1

 According to many analysts, 

however, the CPI overstates increases in the cost of living 

because it does not fully account for the fact that consumers generally adjust their spending patterns as some 

prices change relative to other prices. One option for lawmakers would be to link federal benefit programs and tax 

provisions to another measure of inflation—the chained 

CPI—that is designed to account fully for changes in 

spending patterns. The chained CPI grows more slowly 

than the traditional CPI does: by an average of 0.3 percentage points per year over the past decade. As a result, 

using that measure to index benefit programs and tax 

provisions would reduce federal spending (especially 

on Social Security and federal pensions) and increase 

revenues.

Although many analysts consider the chained CPI a more 

accurate measure of the cost of living, using it for indexing could have disadvantages. Because the values of the 

chained CPI are revised over a period of several years, 

the tax code and affected programs would have to be 

indexed to a preliminary estimate of the chained CPI that 

is subject to estimation error. Also, the chained CPI may 

understate growth in the cost of living for some groups, 

such as older people.

Inflation and Changes in the 

Cost of Living

Inflation—a general increase in the prices of goods and 

services—can be measured in various ways. Traditionally, 

the rate of inflation has been computed by multiplying 

the percentage price change for each item that people 

purchase by that item’s share of consumer spending in 

a period before the prices changed and then summing 

those changes for all items. In a simplified example, imagine that people bought only two things last year, cars and 

cauliflower, and that they divided their spending evenly 

between the two. If the price of cars rose by 4 percent this 

year and the price of cauliflower rose by 7 percent, annual 

inflation would be measured as (0.04 x 0.50) + (0.07 x 

0.50) = 0.055, or 5.5 percent. Such increases would 

reduce consumers’ purchasing power (unless their income 

and wealth rose accordingly).

In reality, however, inflation as measured that way is 

generally higher than the annual growth in the cost of 

living—that is, than the amount of additional resources 

someone would need to maintain the same standard of 

living this year as last year in the face of rising prices. The 

reason for the difference is that many people can soften 

CBO A series of issue summaries from

the Congressional Budget Office

FEBRUARY 24, 2010

1. For more information about the CPI, see Congressional Budget 

Office, Explaining the Consumer Price Index, Issue Brief (June 20, 

2007); and Bureau of Labor Statistics, “Consumer Price Index: 

Frequently Asked Questions” (January 14, 2010), available at 

www.bls.gov/cpi/cpifaq.htm. For technical details about how the 

CPI is calculated, see Bureau of Labor Statistics, BLS Handbook of 

Methods, Chapter 17 (June 2007), available at www.bls.gov/opub/

hom/pdf/homch17.pdf.
2 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

the impact of inflation on their standard of living by 

shifting some of their purchases away from goods or services that have risen in price toward ones that have not 

risen or have risen less. Even with such economic substitution, an increase in the price of a good lowers consumers’ standard of living (unless they value the old good and 

the new good equally). But the resulting decline in their 

standard of living is usually smaller than it would be if 

substitution were not possible. Thus, measures of inflation that do not account for such substitution overstate 

growth in the cost of living, a phenomenon known as 

substitution bias.

The Consumer Price Index and 

Its Limitations

Although the CPI is not a true cost-of-living index, BLS’s 

goal in computing it is to estimate the growth in the cost 

of living by measuring the change in the cost of a “market 

basket” of goods and services that represents average consumer spending.2

 The market basket is based on data 

from BLS’s Consumer Expenditure Survey, in which 

thousands of families report what they actually bought. 

BLS divides those purchases into 211 categories—such as 

breakfast cereal, rent on a primary residence, women’s 

dresses, and wireless telephone services—and assigns a 

percentage weight to each category based on its share of 

consumer spending in a base period. To measure price 

changes, BLS chooses about 80,000 specific items (several 

hundred for each category) and checks their prices every 

month at selected stores and other establishments in 

87 urban areas. 

BLS uses those price data to compute various versions of 

the CPI, two of which are currently used to index federal 

programs. The consumer price index for all urban consumers (CPI-U) is based on the average spending of 

almost all residents of urban or metropolitan areas— 

about 87 percent of U.S. residents. The consumer price 

index for urban wage earners and clerical workers (CPIW) focuses on a subset of the CPI-U population: households that include clerical workers, sales workers, laborers, or certain other types of nonprofessional employees. 

The CPI-W population represents about 32 percent of 

U.S. residents. 

The two versions of the CPI produce similar estimates 

of inflation. Over the past 20 years, CPI-W inflation has 

averaged 2.65 percent a year, and CPI-U inflation has 

averaged 2.69 percent. The Congressional Budget Office 

(CBO) expects that the two measures will grow at about 

the same rate in the future. 

Every two years, BLS uses new survey data to update the 

share of consumer spending devoted to each of the 

211 categories in the market basket. As a result, at any 

given time, the CPI is based on spending patterns from 

two to four years earlier. For example, the monthly values 

of the CPI computed in 2008 and 2009 were based on 

spending data reported in the Consumer Expenditure 

Survey in 2005 and 2006. For the monthly values beginning in January 2010, BLS used new data to update the 

market basket to reflect purchases made in 2007 and 

2008. 

Because the CPI is based on spending patterns from a 

point in the past, it does not fully incorporate the effects 

of economic substitution. Therefore, the CPI grows faster 

than the cost of living does. That substitution bias would 

exist whether the market basket was from one month 

ago or five years ago. However, greater periods of time 

between updates to the basket tend to magnify substitution bias and to cause an even larger gap between the 

increase in the CPI and growth in the cost of living.

BLS’s procedures account for the effects of substitution 

within most basic categories of goods and services in the 

market basket—such as when some consumers who previously bought large grade-A eggs switch to mediumsized eggs when the latter go on sale.3

 However, the index 

does not take into account shifts that occur between one 

category and another. For instance, if the price of apples 

rises by 50 percent and the price of bananas goes up by 

only 10 percent, consumers will tend to buy fewer apples 

and more bananas. Because apples and bananas are separate categories in the CPI market basket, the index does 

not account for the effects of such substitution. As a 

result, it overstates the amount by which consumers’ 

well-being declines when prices rise and understates the 

benefit of price reductions.

2. Bureau of Labor Statistics, BLS Handbook of Methods, 

Chapter 17, p. 2.

3. BLS does not use those procedures for some types of goods and 

services included in the CPI—such as rents, certain utilities, and 

medical services—because consumers cannot easily substitute one 

good for another within those categories.
ECONOMIC AND BUDGET ISSUE BRIEF

USING A DIFFERENT MEASURE OF INFLATION FOR INDEXING FEDERAL PROGRAMS AND THE TAX CODE 3

Figure 1.

Inflation as Measured by the CPI-W, CPI-U, and Chained CPI-U

(Percentage change from one year earlier)

Source: Congressional Budget Office based on data from the Bureau of Labor Statistics.

Note: CPI-W = consumer price index for urban wage earners and clerical workers; CPI-U = consumer price index for all urban consumers.

An Alternative Measure: 

The Chained CPI-U

One way to account for the effects of economic substitution would be to use a market basket of purchases from a 

period after the price changes being measured. However, 

the resulting measure of inflation would be biased downward, just as the current CPI is biased upward. Another 

approach would avoid both types of bias. Since August 

2002, BLS has published an alternative index, the 

chained CPI-U, that attempts to fully account for the 

effects of economic substitution on changes in the cost 

of living.4

 The chained CPI-U provides an unbiased 

estimate of changes in the cost of living from one month 

to the next by using market baskets from both months, 

thus “chaining” the two months together.5

The chained CPI-U produces lower estimates of inflation 

than the traditional CPI does. Since December 2000, 

when such comparisons became possible, the annual 

increase in the chained CPI-U has been 0.3 percentage 

points lower, on average, than the increases in the traditional CPI-U and CPI-W (see Figure 1).

A drawback of the chained CPI-U is that it requires data 

on changes in consumers’ spending patterns. Those data 

do not become available for several years, so BLS releases 

preliminary estimates of the chained CPI-U and revises 

them over the following two years. The preliminary 

values are based on estimates of monthly changes in the 

percentage weights of different categories of goods in 

the market basket (rather than on a biennially updated 

Dec.

2000

June 

2001

Dec. 

2001

June 

2002

Dec. 

2002

June 

2003

Dec. 

2003

June 

2004

Dec. 

2004

June 

2005

Dec. 

2005

June 

2006

Dec. 

2006

June 

2007

Dec. 

2007

June 

2008

Dec. 

2008

-1

0

1

2

3

4

5

6

7

CPI-W

CPI-U

Chained CPI-U

(Final values)

4. Although BLS began publishing the chained CPI-U in 2002, it 

has produced monthly values for the index starting in December 

1999. For more information about the chained CPI-U, see Bureau 

of Labor Statistics, “Frequently Asked Questions About the 

Chained Consumer Price Index for All Urban Consumers” (April 

6, 2005), available at www.bls.gov/cpi/cpisupqa.htm; and Brian 

W. Cashell, The Chained Consumer Price Index: How Is It Different, and Would It Be Appropriate for Cost-of-Living Adjustments?

Report RL32293 (Congressional Research Service, March 23, 

2009). 

5. Another chained measure of prices is the personal consumption 

expenditures price index, which the Bureau of Economic Analysis 

constructs as part of the national income and product accounts.
4 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

basket, as is the case with the traditional CPI). BLS bases 

those estimated changes in spending patterns on measured price changes and any available updated data on 

consumers’ expenditures. 

For each month, BLS releases estimates of the chained 

CPI-U at three points in time. The initial estimate is 

published a few weeks after the end of the month for 

which price changes are being measured, at the same time 

as the traditional CPI. Interim estimates are published 

each February for all months in the previous year, and 

final values for that year are released the following February. For example, an initial estimate of the chained CPI-U 

for January 2008 was released in February 2008. Interim 

estimates for January 2008 through December 2008 were 

released in February 2009, and final values for 2008 were 

published in February 2010. By contrast, the values of 

the traditional CPI that are currently used to index 

federal programs are not revised.6

Using the Chained CPI-U to Index 

Federal Programs and the Tax Code 

Indexing federal programs and tax provisions for inflation 

is designed to maintain purchasing power for recipients 

of federal benefits over time and to tax similar amounts of 

real (inflation-adjusted) income at roughly the same rates 

over time.7

 The parameters of various federal programs 

are indexed to changes in the traditional CPI. For 

instance, the annual cost-of-living adjustments (COLAs) 

made to Social Security benefits and federal pension 

benefits are based on the CPI-W. The federal poverty 

guidelines—income thresholds that are used to determine 

eligibility for many support programs aimed at lowerincome people—are indexed to the CPI-U. Programs 

that use the poverty guidelines include Head Start, the 

Supplemental Nutrition Assistance Program, the 

National School Lunch Program, the Low-Income 

Home Energy Assistance Program, the Children’s Health 

Insurance Program, and parts of Medicaid.8

Parameters of the tax code that are indexed for inflation 

include the amounts of the personal and dependent 

exemptions; the size of the standard deductions; the 

income thresholds that divide the rate brackets for the 

individual income tax; the size of tax-deductible contributions to retirement accounts, such as 401(k) plans; 

the amount of annual gifts exempt from the gift tax; and 

the thresholds and phaseout boundaries for the earned 

income tax credit and several other credits. If those values 

were not indexed, average tax rates would gradually rise 

because of inflation.9

 All of those parameters are indexed 

by adjusting them for the growth in the average monthly 

CPI-U between a base year (which runs from September 

through August) and the most recent September-toAugust period.10

An alternative to current law would be to index federal 

programs and the tax system to the chained CPI-U rather 

than the traditional CPI-U or the CPI-W. Because the 

chained CPI-U generally grows more slowly than the 

traditional CPI does, such a change would reduce federal 

outlays and increase revenues. For example, in its most 

recent Budget Options volume, CBO estimated the budgetary effects of using the chained CPI-U for indexing in 

three instances.11 Switching from the traditional CPI-U 

to the chained CPI-U to index parts of the tax code 

would reduce budget deficits by a total of about $90 billion over 10 years.12 Using the chained CPI-U to set 

6. BLS also releases values of the CPI that are adjusted to remove 

the effects of seasonal influences (such as the fact that although 

oranges are available year-round, they are much more expensive in 

the summer when they are out of season). The seasonally adjusted 

values of the CPI are revised, but those values are not used to 

index federal programs.

7. For more information, see Brian W. Cashell, Automatic Cost-ofLiving Adjustments: Some Economic and Practical Considerations,

Report RL34168 (Congressional Research Service, January 11, 

2010).

8. For a more detailed list of programs, see Department of Health 

and Human Services, “Frequently Asked Questions Related to the 

Poverty Guidelines and Poverty” (January 25, 2010), available at 

www.aspe.hhs.gov/poverty/faq.shtml#programs.

9. Even with indexing, average tax rates tend to increase over time as 

the real growth of income (growth above and beyond the effects of 

inflation) pushes taxpayers into higher tax brackets.

10. September-to-August averages are used instead of calendar year 

averages because they allow enough time to incorporate the new 

dollar amounts for indexed parameters into tax forms for the 

coming year.

11. See Congressional Budget Office, Budget Options, Volume 2

(August 2009), pp. 132–133, 147–148, and 186.

12. The $90 billion estimate, which was produced by the staff of the 

Joint Committee on Taxation, represents the change in the overall 

budget balance that would result from changes in both revenues 

and outlays.
ECONOMIC AND BUDGET ISSUE BRIEF

USING A DIFFERENT MEASURE OF INFLATION FOR INDEXING FEDERAL PROGRAMS AND THE TAX CODE 5

COLAs for Social Security would lower outlays by 

$108 billion over a decade, and using that index to set 

COLAs for federal civilian and military pensions and 

veterans’ benefits would reduce outlays by $23 billion 

over 10 years. 

Switching to the chained CPI-U would be complicated, 

however, by the delay in releasing the final value of the 

index. One way around that problem would be to base 

adjustments on the initial release of the chained CPI-U, 

which generally differs only slightly from the final value. 

That approach would be equivalent to applying the initial 

estimate of inflation in the past year, adjusted for revisions to previous estimates. (Details of those calculations 

for tax provisions, Social Security, and pensions are presented in a technical appendix available on CBO’s Web 

site.)

As an illustration of the issues involved, consider the tax 

code. In the base year of 1987, the standard deduction for 

a single tax filer was $3,000. Between that time and the 

year ending in August 2009, the CPI-U rose by 91.1 percent. Correspondingly, the standard deduction (rounded 

down to the nearest $50 increment) increased to $5,700 

in 2010. 

To switch from the traditional CPI-U to the chained 

CPI-U, tax law could be amended to use a new base 

year for which the final value of the chained CPI-U was 

known. The amount of the deduction (or other relevant 

tax parameter) would then equal the amount in the base 

year adjusted for the initially estimated growth in the 

chained CPI-U since then. In subsequent years, the 

amount of the deduction would change not only to 

reflect estimates of inflation for the most recent year but 

also to reflect updates in the estimates of the chained 

CPI-U for previous years. For instance, the base year for 

the standard deduction could be moved from 1987 to 

2005, with a base value for the deduction of $5,000 in 

2005 and a base value for the chained CPI-U of 100 in 

the year ending in August 2005.13 If the initial chained 

CPI-U for, say, the year ending in August 2014 was 120, 

then the standard deduction in 2015 would be $6,000 

[(120/100) x $5,000]. 

Suppose that the following year, the initial release of the 

chained CPI-U for the year ending in August 2015 was 

125, and the value for 2014 was revised from an initial 

estimate of 120 to an interim estimate of 121. (In reality, 

the revisions between initial and interim estimates tend to 

be much smaller than the 0.8 percent used in this simplified example.) That revision indicates that the $6,000 

standard deduction used in 2015 should have been 

$6,050 [(121/100) x $5,000].

In 2016, the standard deduction would be $6,250 

[(125/100) x $5,000]. That would represent a 4.2 percent increase from the previous year’s deduction of 

$6,000, even though the estimate of inflation would be 

3.3 percent (the growth from 121 to 125). Effectively, the 

revision of the chained CPI-U for 2014 indicated that the 

initial estimate used to set the 2015 value of the standard 

deduction was too low. Therefore, the growth in the 

deduction the following year (from $6,000 to $6,250) 

would be higher than the new estimate of the most recent 

year’s inflation in order to make up for the understatement in the previous year. In that way, that error would 

affect only the value of the 2015 deduction and would 

not persist in 2016 or later years.14 Errors in initial and 

interim estimates of the chained CPI-U for later years 

would affect the value of the standard deduction in each 

subsequent year but would not cumulate.

Effects of Revisions to the 

Chained CPI-U

Because the initial release of the chained CPI-U is based 

on incomplete data, using it to index federal programs 

would introduce some errors, as described above. When 

the chained CPI-U was first published in 2002, BLS had 

little data available on which to base the methodology it 

used to estimate the initial and interim values, so it began 

with a simple model. As a result, the initial values of the 

index have generally been lower than the final values (see 

Figure 2). For example, from 2002 through 2008, the difference between the initial and final values for the third 

quarter of the calendar year—the quarter whose values 

are used to index Social Security and pension benefits—

ranged from 0.18 percent to 0.62 percent. On average, 

the difference was 0.35 percent. As a result, had the initial

13. For clarity, the index is rebased in this example. The current base 

period for the chained CPI-U, in which the index equals 100, is 

December 1999, and the average of the final values of the chained 

CPI-U for the 12 months ending in August 2005 was 112.43.

14. If the final value of the chained CPI-U for 2014 differed from the 

interim estimate of 121, the 2016 deduction would be adjusted in 

a similar way.
6 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

Figure 2.

Initial, Interim, and Final Values of the Chained CPI-U

(Index value)

Source: Congressional Budget Office based on data from the Bureau of Labor Statistics.

Note: CPI-U = consumer price index for all urban consumers.

estimates of the chained CPI-U been used to set Social 

Security COLAs during that period, benefit payments 

would have been 0.35 percent lower, on average, than if 

the final values of the chained CPI-U been used. Likewise, the initial or interim values available for tax indexing—covering the 12-month period from September to 

August—were 0.05 percent to 0.27 percent lower than 

the final values from 2002 through 2008.15

Now that multiple years of data are available, BLS is 

investigating better methods for estimating the preliminary values of the chained CPI-U. If such a method was 

adopted, the initial and interim values of the index would 

still differ from the final value, but the differences should 

be notably smaller than in the past.

With one of those better methods in place, the effects of 

revisions to the chained CPI-U would be small compared 

with the overall effect of switching from the traditional 

CPI-U to the chained CPI-U. The gap of about 0.3 percentage points between inflation as measured by the traditional and the chained indexes compounds over time, 

whereas the effect of any revisions between the initial and 

final values of the chained CPI-U would not compound. 

In the case of Social Security and federal pensions, using 

a different index would not affect initial benefit levels, 

now or in the future. The effects would be felt with each 

COLA, when benefits would be slightly smaller than they 

would have been without the change in indexing. The 

impact would be greater the longer people received benefits (that is, the more COLAs they experienced). For 

example, after 10 years of COLAs, the Social Security 

benefits paid to a 73-year-old who had claimed initial 

retirement benefits at age 62 would be about 3 percent 

lower, on average, if the chained CPI-U was used for 

indexing instead of the CPI-W.

Jan. 

2002

July 

2002

Jan. 

2003

July 

2003

Jan. 

2004

July 

2004

Jan. 

2005

July 

2005

Jan. 

2006

July 

2006

Jan. 

2007

July 

2007

Jan. 

2008

July 

2008

Jan. 

2009

July 

2009

Jan. 

2010

0

100

105

110

115

120

125

130

Initial Interim Final

15. Those figures compare the final values with the average of the 

interim values for September through December of one calendar 

year and the initial values for January through August of the 

following calendar year. 
ECONOMIC AND BUDGET ISSUE BRIEF

USING A DIFFERENT MEASURE OF INFLATION FOR INDEXING FEDERAL PROGRAMS AND THE TAX CODE 7

Measures of Inflation for 

Specific Populations

The consumer price index reflects prices paid for the 

goods and services purchased by an average household, 

not by any specific individuals or age groups. Therefore, 

most people experience price changes that are either 

higher or lower than reported in the CPI. Computing 

changes in the cost of living separately for each individual 

would not be feasible, but different indexes could be 

calculated for other subgroups of the population or for 

different policy purposes.

The possibility that the cost of living may grow at a 

different rate for the elderly than for the rest of the population is of particular concern because Social Security 

benefits are the main source of income for many older 

people. BLS computes an index that reflects the purchasing patterns of older people, called the experimental CPI 

for Americans 62 years of age and older (CPI-E). Since 

1982 (the earliest date for which that index has been 

computed), annual inflation as measured by the CPI-E 

has been 0.2 percentage points higher, on average, than 

inflation as measured by the traditional CPI-U and 

0.3 percentage points higher than inflation as measured 

by the CPI-W. If policymakers believed that the CPI-E 

was an appropriate measure of inflation for the elderly, 

they could use it to index programs that serve that population. A chained version of the CPI-E could also be 

developed to better account for economic substitution 

by older consumers. 

It is unclear, however, whether the cost of living actually 

grows at a faster rate for the elderly than for younger 

people. The elderly tend to devote a larger-than-average 

portion of their out-of-pocket spending to health care, so 

changes in health care prices play a disproportionate role 

in their cost of living. But determining the impact of rising health care prices on the cost of someone’s standard of 

living is problematic because it is difficult to accurately 

account for changes in the quality of health care. Both 

treatment costs and the value of improved treatments 

often increase rapidly. Thus, more uncertainty exists 

about measures of price growth for health care than for 

other goods and services. Some research suggests that 

BLS underestimates the rate of improvement in the 

quality of health care and that such improvement may be 

reducing the true price of health care by more than 1 percent a year.16 If that is the case, then all versions of the 

CPI overstate growth in the cost of living, with the overstatement especially large for the CPI-E.

The CPI-E differs from the CPI-U only by using different percentage weights for the 211 categories of goods 

and services in the CPI market basket. New indexes could 

be constructed that would also reflect the differences in 

different populations’ purchasing patterns within those 

categories. Such indexes could be based, for example, on 

information from retail stores that showed the specific 

items being purchased by elderly people or other segments of the population. 

16. See Robert J. Gordon, The Boskin Commission Report: A Retrospective One Decade Later, Working Paper No. 12311 (Cambridge, 

Mass.: National Bureau of Economic Research, June 2006), 

pp. 24–25, available at http://papers.nber.org/papers/w12311.

This issue brief was prepared by Noah Meyerson of 

CBO’s Health and Human Resources Division. It and 

other CBO publications are available at the agency’s 

Web site: www.cbo.gov.

Douglas W. Elmendorf 

Director