24 Pages Posted: 30 Jan 2020 Last revised: 16 Apr 2020
Date Written: January 9, 2020
Inflation indexing is an important and controversial issue in the design of tax systems and transfer programs. The choice of whether — and how — to adjust policy parameters for inflation carries significant political, distributional, and macroeconomic implications. In recent years, indexing has gained particular attention in three policy contexts: (1) whether to switch from an “unchained” to “chained” inflation index when calculating Social Security benefits; (2) whether to make a similar unchained-to-chained shift when setting federal income tax parameters such as bracket thresholds and deduction amounts; and (3) whether to index basis for inflation when calculating capital gains. Hundreds of billions of dollars ride on the resolution to these three questions.
Across all of these contexts, the debate over inflation indexing is generally framed in terms of “accuracy.” Advocates on one side argue that the use of a particular index would lead to more accurate cost-of-living adjustments or more accurate assessments of tax liability, while opponents of the change contest those claims. This Article — an invited contribution to a symposium issue on Law and Macroeconomics, based on remarks at a September 2019 conference at Georgetown University Law Center — argues that the emphasis on “accuracy” misses the mark in two respects. First, inflation is not a quantity that exists in the world apart from how it is measured. To say that chained CPI is more “accurate” than unchained CPI is something like saying that a U.S. liquid pint measure is more “accurate” than an imperial pint measure. Second, the adjustment of policy parameters over time is not, at its core, a question of technical accuracy but instead a question of normative values. “Accuracy” in this context turns out to be both an illusion and a distraction.
Seeing through the mirage of “accuracy” is important not only because it offers a clearer-eyed view of the values at stake in indexing debates, but also because it opens up broader vistas for tax and transfer policymaking. For example, rather than focusing on whether “unchained” or “chained” versions of the Consumer Price Index provide more “accurate” measures of inflation, we might ask whether pensioners and disabled adults ought to share in the gains from economic growth. Likewise, instead of a crimped choice between unchained and chained CPI for tax bracket thresholds and deduction amounts, we might imagine tying tax system parameters to deficit levels or business cycle measures. And instead of an argument about capital gains indexation framed in “accuracy” terms, we might imagine a more direct discussion about whether (and how much) the income tax should operate as a tax on wealth. The Article points to ways in which indexing can be “unchained” from a narrow focus on “accurate” measurement of inflation and can explicitly account for the range of factors that enter into distributive decisionmaking.
Keywords: inflation indexing, chained CPI, Social Security, capital gains
JEL Classification: K34, E3, H24
Suggested Citation: Suggested Citation