Essay: The Cost of Living and the Consumer Price Index

Fiddling the CPI

The high cost of living isn't so bad if you don't have to pay for it.
Don Marquis, "Archy and Mehitabel", 1927

 

On December 4, 1996, a committee to study the Consumer Price Index under the leadership of Michael Boskin, Former Chief of the U.S. Council of Economic Advisers, presented its final report to the United States Senate.

This study declared that in 1996, the Consumer Price Index had been overstated and that the index should have been 1.8%, instead of the reported figure of 2.9%.

The Boskin Report also concluded that the CPI had been overstated by a similar amount in each of the last twenty years.

If this were true, it meant the government was doing an even better job controlling inflation and that productivity was higher than previously announced.

Since the government uses this index to adjust many statistics, such as GDP per capita, reducing the CPI improves perceived economic performance.

Boskin's Recommendations

The Committee recommended changes in the method of calculating the CPI that would increase taxes and reduce entitlements. This would make it easier for President Clinton to balance the budget.

The Boskin report reflected the political environment in which public servants in the Bureau of Labor Statistics followed the lead of their political bosses.

Although the recommendations of the Boskin Report to restate past CPI calculations were not adopted, the biases of the report have bored into the bureaucratic woodwork and influence the production of these statistics today.

Economists seemed willing to fiddle the CPI to achieve political goals

The economists seem to have been willing to fiddle the CPI to harm the citizenry and achieve political goals.

Lowering the CPI reduces the correction for inflation on social security payments and veterans’ benefits and pensions.

The bureaucracy gains by increased income taxes from the slowing of adjustments in tax brackets and exemptions mandated under the Economic Recovery Tax Act of 1981.

The experts making these recommendations were government employees and people whose livelihood depended, directly or indirectly on government funds.

In medieval times, few were brave enough to question church teachings that protected the divine right of kings.

Today, not enough people have the courage and commonsense to question the academic and government economists who report changes in their cost of living.

Flaws or Deception?

Knowing how the consumer price index is made helps when making judgments about investment markets.

We need to examine the way that economists measure inflation and not take them at their word.

It would take a thousand pages to describe the details of the CPI – enough reading to induce irresistible sleep and our surrender to the wisdom of government sages.

However, a summary of the essential points quickly reveals flaws and deception in the CPI:

Start With The Wrong Market Basket. Every ten years, employees in the U.S. Bureau of Labor Statistics conduct a survey of consumer behavior to set up a weighted 'market basket of goods and services' that supposedly represents typical outlays of the average citizen. Consumer Price Index and the Cost of Living: Lower Middle Class Bias Public employees adjust this 'basket' each decade for changes in lifestyle. The adjustment is subjective and only reflects two lifestyles. The CPI-W claims to represent living conditions in lower middle class and poor urban households who get their primary source of income from wages and salaries as clerical workers (i.e., Archie Bunkers, not executives).

Over the last fifty years, there has been a visible decline in the living standards of the poorer classes, with urban decay and crime in the inner cities providing commonsense evidence that lifestyles in poor urban households have been deteriorating, despite the happy picture suggested by the CPI-W. The CPI-U includes non-wealthy urban consumers (wage earners, salaried workers, the self-employed, retirees, and the unemployed).

The CPI-U tracks living patterns of the lower eighty percent of the population. So, the CPI-U excludes cost of living measurement for that portion of the population that accounts for over fifty percent of national income and ninety percent of financial wealth.

If you have a college education and are an U.S. resident reading this essay, it is probable the CPI-U does not reflect your lifestyle and substantially understates changes in your cost of living.

Use A Biased Ruler. Since the 'basket of goods and services' is readjusted each decade, the Consumer Price Index can hide the reality of a population that is gradually sinking into poverty.

For example, if lower wages force Americans to take the bus to work, rather than drive their cars, the economists will substitute the cost of bus fare for the cost of an automobile.

Substitute Cheaper Goods. When the price of sirloin gets too high, most people will substitute a cheaper cut of meat. The economists call this the 'substitution effect' and the Boskin Committee recommended that every time something gets too expensive, the economists who calculate the Consumer Price Index should substitute cheaper goods or services to reflect consumer behavior.

Obviously, this makes it appear that living costs have not increased. Even if the cost of food climbs to such a degree that people live on starvation diets, these economists will ignore increased costs and switch to measuring the cost of living at ever-lower standards.

Buy In Cheaper Stores. The Boskin Committee said that if people can no longer shop at Macy’s but now shop at the flea market, in less comfort, the government should use flea market prices in the CPI.

They see 'outlet substitution bias' in the poorer worker’s inability to shop where she would like.

Discount Technological Advances. The Boskin Committee fretted that when products are improved, 'quality bias' is introduced into the cost of living statistics. For example,when we compare the features of a 1937 automobile with a 1980 model, we find many improvements and also higher cost.

The economists do not think it would be fair to compare the price of a 1980 Dodge with the 1937 version, without some adjusting for changes in quality. They will adjust downwards the price of the 1980 car, to achieve this.

Of course, a real person can hardly ask the automobile salesmen to provide a similar discount, nor can he buy the 1937 model or go without a car to get to work. By adjusting for 'quality bias', the economists understate the real cost of living.

There is no adjustment for declining quality of goods or services

Distortions are accentuated when the government mandates certain features (such as catalytic converters) but then discounts the costs of these 'improvements' when calculating the cost of living. The dishonest bias of this 'quality adjustment' is obvious when we understand that the government makes no similar upward cost adjustment for products and services that have fallen in quality.

When I was a boy, milk was delivered to our doorstep. Sixty years later, we must go to the store. For the Bureau of Labor Statistics to make a fair 'quality adjustment', the price of milk would have to be increased to reflect this lack of service and convenience.

Similar adjustments would have to be made for doctors who no longer make house calls, the collapse of service on passenger trains, and the shrinking space allocated for airplane economy class seats.

Ignore Taxes. The CPI does not take income and social security taxes into consideration, although this is a cost that citizens cannot avoid.

The government ignores the cost of taxes

A widow, who goes without medical care and is forced to live on a simpler diet because of rising prices, has no such choice when it comes to satisfying tax authorities.

Since government income increased over six percent each year throughout the 1990s, and since many Americans spent from ten to thirty percent of their budget on taxes, the bias of the government economists is strikingly clear.

Jiggle the Weights. In fixing the weights used on the 'basket of goods and services', the Bureau of Labor Statistics has an opportunity to distort changes in the cost of living.

The weights used in 1999 were as follows:

Housing

41.3%

Food & Drinks

17.3%

Transportation

17.1%

Medical Care

7.4%

Apparel and Upkeep

5.5%

Entertainment

4.4%

Other

7.1%

Political bias can be introduced in the CPI by adjusting the weights in each category. For example, outlays on medical care were about fifteen percent of national consumer spending in 1999 — twice the figure used in the CPI calculation.

Medical costs are clearly understated

In the period 1958-1999, medical costs increased twelve times, while food costs rose about five times. By understating components of the CPI, the government defrauded senior citizens who had the greatest health care expenses.

For those dependent on social security, misrepresenting this weight has consequences on their lives.

Pretend Americans Are Renters. An important feature of the American economy is that most people own their home. However, the CPI is calculated as if most Americans were renters.

Although the interest on mortgages is deductible from taxes, other ownership expenses are not similarly favored.

By using rentals rather than homeowners' costs, the CPI understates the cost of living

A homeowner cannot take off depreciation, repairs, insurance, or utility costs.

However, a landlord has these deductions, and so, in most non-resort areas, the long-term cost of renting a home is less than that of owning a home.

This means that the CPI (using rentals as a base) understates the cost of living for most Americans. In many locations, it is difficult to find houses for rent that are equivalent in quality and condition to houses for sale.

Americans are mobile, moving on the average every seven years. The cost of real estate commissions is an expense that is not reflected in the cost of rentals.

Considering the government’s interest in misreporting inflation to increase taxes and lessen entitlement payments, we should not be surprised that the CPI is doctored.

Besides, although economists use the CPI to deflate just about every data series that they get their hands on, the CPI is not the same as a 'cost of living' index.

People with a nest egg that provides meaningful retirement income will find that using the CPI as a surrogate for inflation will result in a poorer life style than they currently enjoy.

An Impossible Standard?

It would be useful to have a reliable cost-of-living index to measure inflation, but no one has devised a number that reflects living costs for large, diversified populations.

The American CPI ignores living standards of citizens who account for fifty percent of national income and ninety percent of financial wealth.

A true Consumer Price Index is a fantasy

Even for poorer people, the CPI is not reliable, since economists change the yardstick as living standards rise or fall.

A true Consumer Price Index is a fantasy.

The quality and nature of goods and services are in flux and there are constant changes in lifestyle and living standards.

In the real world, there is no typical consumer and so the CPI either overstates or understates the cost of living for almost everyone.

Government Securities Fraud

The U.S. government offers Treasury Inflation-Indexed Securities (TIPS), with the following declaration on the web site of the Bureau of the Public Debt:

If U.S. Treasury bills, notes, and bonds are the world's safest investments – and they are – then you might say Treasury Inflation-Indexed Securities are the safest of the safest. Why? Because their ultimate value cannot be diminished by inflation. …

Unlike the situation with other notes and bonds, the interest and redemption payments for Treasury Inflation-Indexed Securities are tied to inflation. … As for federal taxes, here's one matter to consider: In any year when the principal of your security grows, that gain is considered reportable income for that year even though you won't receive your inflation-adjusted principal until the security matures.

The basis for indexing of TIPS is the CPI, not inflation. This index reports costs relevant to the poorer half of American society.

The government claims about TIPS remind us of practices that might draw the attention of the SEC for misrepresentation if perpetrated by a private issuer.

The government says the principal on TIPS is protected against inflation.

However, this is deceptive, since the principal is adjusted for changes in the CPI, not inflation, and is reduced by taxes. Besides, these taxes are prepaid, years before the investor receives the principal.

Over the life of ten-year TIPS, an investor who fell for the government claim of inflation-protection will find that ten to fifteen percent of the principal of this 'safest of the safe' bond is confiscated in taxes.

The investor’s money is not, in fact, returned intact with monetary correction.

July 25, 2004

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