Consumer Price Index and Colas

The CPI is the primary source of information concerning trends in consumer prices and inflation in the United States. As a measure of inflation, it is one of the nation's most important economic indicators, and affects nearly all people living in the United States as well as many Americans living abroad. It is also used to create "constant dollar" key economic indicators. Such indicators include, but are not limited to, estimates of income, earnings, productivity, output, and poverty. The index is also widely used for economic analysis and policy formation in the public and private sectors.

The CPI is often employed as a cost-of-living adjustment (COLA), even though it is not a cost-of-living index. It is used to adjust wages and benefit payments to account for the erosion of consumer purchasing power due to price increases faced by consumers. The CPI is the best measure for adjusting wages and payments when the goal is to allow consumers to purchase, at today's prices, a market basket of goods and services equivalent to one that they could have purchased at an earlier time. This is the type of adjustment often called for when the CPI is applied to meet statutory obligations. Such obligations include payments to Social Security beneficiaries and federal and military retirees— all of which are tied to the CPI-W—and those for a number of entitlement programs, including food stamps and school lunches. The impact on the finances of the federal government is quite significant when such adjustments are made. Annual escalation adjustments in the federal income tax brackets, as well as personal exemption and standard deduction amounts, are made using the CPI-U. With regard to the impact on federal taxes, it has been estimated that in the fiscal year 1996, each 1 percent increase in the CPI resulted in a $5.7 billion increase in outlays and a $2.5 billion decline in tax revenues.