Consumer Price Index

Cost-of-Living Concepts and the Housing and Medical Care Components Gao ID: GGD-96-166 August 26, 1996

The Consumer Price Index (CPI) measures the price of a fixed market basket of goods and services, organized into major components, such as transportation and medical care. The government used the CPI in fiscal year 1995 to adjust for inflation billions of dollars worth of federal spending and tax receipts--affecting program beneficiaries and taxpayers alike. Although it is often referred to as a cost-of-living index, the CPI is not designed for this purpose. A comprehensive cost-of-living index does not exist. In response to congressional concerns that taxpayers could be negatively affected if the estimation problems of the CPI were not well understood, this report (1) discusses whether a change made to the housing component in the early 1980s made the CPI either more or less suitable for use as a cost-of-living measure and (2) identifies the advantages and the disadvantages of changing the current measurement of medical care costs to an approach that would more closely match a cost-of-living measure.

GAO found that: (1) the CPI is not a cost-of-living index, but a measure of the change in prices paid for a fixed market of goods and services; (2) a comprehensive cost-of-living index is broader in coverage than an index based on consumer expenditures and budgets; (3) the Bureau of Labor Statistics (BLS) uses the rental equivalence method to better measure housing costs within the CPI structure; (4) this method has made the CPI more suitable for measuring cost of living; (5) two-thirds of medical care expenses are excluded from the CPI, since they are paid by third parties payers; (6) including third-party payments in the CPI would move the CPI towards a cost-of-living index; (7) BLS excludes third-party payments from the CPI to better represent direct expenditures by consumers; (8) changing the medical care component of CPI would improve the formulation of health-care-specific policies and macroeconomic policies, but there is little technical feasibility in making such changes; (9) the Stigler committee believes that CPI should better reflect the cost-of-living index; (10) it is difficult to design a cost-of-living index for the federal government because of the additional uses of CPI; and (11) policymakers need to consider how the CPI will be affected by changing the medical care component and whether any single price index can account for such cost-of-living measurements.

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