04/17/2013 03:35 pm ET Updated Jun 17, 2013

Chained CPI Is a Fraud: Set Constant Dollar COLA, Not Percent COLA

The president is asking Congress to change the way cost of living adjustments (COLAs) are determined for retirees and eventually federal civilian and military employees. This is needed because reducing the federal debt requires seniors to take a hit for the country so corporations, Wall Street financiers, and others in the top 10 percent don't see an income tax increase, closure of tax loopholes, or reduced income deductions.

The change to the way the COLA will be determined is from something called the CPI-W (Consumer Price Index for Urban Wage Earners and Clerical Workers) to something called Chained CPI (Chained Consumer Price Index). Neither formula includes changes in prices of highly volatile items, like fuel and food. Did you get that? The consumer price index, the index used to calculate everything from the gross domestic product to the price of at-risk kids' school lunches, does not include the change in price of food and fuel. The proportion of income that goes to food and fuel exceeds 50 percent for a low income family, but is less than 20 percent for a high income one. And remember: the money the fed puts into COLAs goes directly back into the economy in the form of purchased goods and services. It does not end up in risky investments, offshore accounts, or other tax evasion schemes.

Using the Chained CPI to set the COLA is a fraud. It requires retirees to lower their standard of living. It implies retirees don't have the same values tomorrow as today. It assumes a senior will hunt for bargains at discount stores. It assumes retirees will go cheap on food. It assumes retirees will turn the heat down and the cool up to save home energy costs. It assumes retirees will stay home and read a book instead of going out or watching cable TV. It assumes retirees don't mind spending most of their income on health care. It assumes seniors can live on less each year.

Inflation is real; it costs more tomorrow to buy what I bought yesterday. The things I have to buy -- gas, food, clothing, shelter, medicine -- increase in price regardless of my economic status. The things I'd love to buy -- fancy phone, fancy clothes, restaurant meals, a new car -- increase in price according to my economic status. COLAs should reflect the increased cost of things I must have, not the increased cost of things I want. And the increase cost of things I must have is the same for everyone, regardless of their economic status. It is a uniform value, not a percent one. As the expression goes, "All boats rise with a rising tide" -- not less for a cheap boat and more for an expensive one.

The current determination of annual increases in Federal salaries and pensions uses a percent figure. The CPI-W assumes that if the the urban wage earner's costs of living increases 1.4 percent, then everyone's costs of living increase 1.4 percent. The chained CPI would reduce this amount to 1.1 percent. So the cost of living increase for all federal military and civilian retirees, Social Security retirees, and even the school lunch program, would be 1.1 percent regardless of the income level. It seems fair, everyone gets the same percentage, until you examine the details. A $15,000 earner gets a $165 increase, while a $150,000 earner gets over $1650. Why should an already high earner get an even larger increase? To be able to purchase more expensive food, heat larger homes, and drive more than a lower wage earner? And remember that more dollars are put into the economy when a lower wage person has an income increase since a higher percent of their income goes to purchasing basics.

But there is an even bigger problem. Remembering your high school algebra class, a percent increase is an exponential function. One exponential function we all know is compound interest. Compound interest is great if you are saving (think interest on your savings account) but horrible if you are paying (think interest on your unpaid credit card balance.) Exponential increases in federal salaries and pensions (percent COLAs) will bankrupt the Federal budget. And they do not raise all boats equally. Some sink while others rise far above the tide. The system must be changed, for both retired and federal employees.

Social Security and federal retirees receive annual increases based on a COLA percent. (Federal civilian and military employees used to get an annual increase that mirrored the COLA; they have not received a pay increase in three years.) Say the COLA is determined to be 1.4 percent. A person on Social Security disability income receiving $11,000 a year will get a $154 increase, while a retired judge receiving $180,000 a year will get a $2,500 increase. A typical retiree receiving $36,000 a year will see a $500 increase. These different increases make no sense. The COLA does not cover the increased costs in food and energy for the lower income person, while a higher income person gets more than they really need.

The annual increase in federal salaries and pensions should be determined in a fair way. Find the median wage retiree, whether it be urban, suburban, or rural. Determine how much that person's real costs have gone up. Say it is 2 percent. Use that to calculate the COLA, and apply that dollar value to everyone. For example, if the median salaried retiree is getting $36,000 a year, then 2 percent is $720. Everyone, from the disabled vet to the judge will get a $720 COLA. Apply a similar adjustment to current federal employees, both civilian and military. All boats rise with a rising tide the same amount, as they should. And the money will circulate in the economy, increasing the general welfare. All good.

This proposal is fair. It raises incomes for all equally, it improves the economic condition of those at the lower end, it is realistic in terms of offsetting increases in expenses of necessities, and it might just save the Treasury.