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More Taxes, Fewer Benefits - and Fewer Votes?

A controversial proposal would change the yardstick for inflation - good news for the budget and the US economy. But it would squeeze many pocketbooks.

Imagine the political firestorm if Congress cut Social Security pensions an average $2,148 per couple over five years.

Or if Congress soaked taxpayers an extra $1,600 by 2006.

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Yet the White House and congressional Republicans are considering just that: an agreement to change the cost of living index, which in turns affects the size of Social Security checks and tax bills.

That possibility faded somewhat last week, as the two sides again deadlocked over a balanced budget.

But the issue is unlikely to go away, because it boils down to this: balancing the federal budget in part by using a new inflation index.

The savings would come from taxpayers, people who receive Social Security checks, and others whose incomes are tied to annual cost-of-living adjustments.

The Boskin commission, appointed by the Senate Finance Committee, says inflation is overstated. The consumer price index (CPI), it says, is too high by about 1.1 percentage points a year.

So where the CPI currently pegs inflation at 3 percent, it should be 1.9 percent.

The implications are considerable, including a sharp reduction in the deficit and Social Security checks.

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Here are some issues:

How would lower cost-of-living adjustments affect taxpayers?

Most taxpayers will show more income, taxed at a higher rate - which means higher taxes.

The cut-off points for the five income-tax brackets are indexed to the CPI. For example, a couple with a $40,000 annual income could land in a higher tax bracket.

Citizens for Tax Justice, a liberal Washington think tank, finds the average taxpayer will see taxes rise 0.7 percent of income by 2006, if the CPI is lowered by one percentage point.

That amounts to $1,600.

A lower CPI also means a smaller reduction in income to reflect inflation.

The personal exemption for each family member would be smaller, as would the standard deduction.

What about people who receive Social Security checks?

Smaller checks, by about $8 a month if the change took place this year.

Social Security checks work off a formula that includes the employee's age at retirement and the highest-earning 35 years between the ages 22 and 61.

This pension is raised each year based on the CPI from the previous year.

If the CPI is adjusted downward, so is the increase in the pension benefits.

A one percentage point reduction will cost an average couple $2,148 over the next five years, figures the Economic Policy Institute (EPI), another Washington think tank.

Who else gets hit?

Low-income taxpayers.

Many receive an earned-income tax credit, and that credit will shrink.

A lower CPI essentially pushes people into higher tax brackets, which means low-income tax payers will find themselves in brackets that deliver a smaller tax credit.

The EPI puts the loss for a family earning $20,000 near $1,650 over 10 years.

Other, similar indexed benefits include pensions and benefits for veterans, federal employees, and railroad workers.

Also on the hit list: Supplemental Security Income, food stamps, and school lunches. The last two are linked to the official poverty line; fewer people would be considered poor.

Would an adjusted CPI be fairer?

Congress presumably wanted taxes, Social Security benefits, and other indexed benefits safeguarded from inflation. That's why it passed indexation measures.

So if the Boskin commission is right that the CPI is too high by 1.1 percentage points a year, prices have been rising more slowly than many incomes.

That means Social Security pensioners and others have been overcompensated, paid more than Congress intended.

But the findings of the commission, headed by Michael Boskin, who was a top economic adviser to President Bush, are controversial.

Some economists argue that the CPI understates inflation, not overstates it. Others say the commission exaggerates the overstatement.

How much would a CPI adjustment reduce the federal deficit?

A lot. If the CPI were cut one percentage point a year, it would trim $52.8 billion from the deficit by 2002, the Congressional Budget Office estimates (see top chart, left).

Federal revenues would rise. Federal spending would fall.

Revenues would rise $18.9 billion, Social Security outlays would fall $19.4 billion; federal civil service retirement costs would be down $2.2 billion; earned income credit payments down $2.5 billion; debt service charges down $6.3 billion.

Balancing the budget by 2002, however, will require more than just a CPI change.

Who should fix the CPI?

Federal Reserve chairman Alan Greenspan has suggested a special commission, appointed by Congress.

Bipartisan support for such a commission is strongest in the Senate, but the House leadership is wary.

Many economists would prefer to leave the matter to the professionals at the Labor Department's Bureau of Labor Statistics, which compiles the index.

Who else loses?

Maybe the president and members of Congress, if they support the change.

Retirees are a potent power in American politics. Many are against the CPI change and might be willing to vote their feelings.

Who else benefits?

Anyone who spends or invests money. The federal budget probably won't be balanced without this change. And a balanced budget would likely mean lower interest rates and a higher stock market.

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