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Changing the Consumer Price Index, the way to measure inflation, is our lead story tonight. Our economics correspondent, Paul Solman of WGBH-Boston is in charge.

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PAUL SOLMAN: The commission that waited today with a new plan to measure inflation actually comes after years of debate among economists, as well as periodic interest from politicians. We, ourselves, reported on the issue back in 1991, when we first looked at the Consumer Price Index better known as the CPI and whether it's overstated. Here's an excerpt from that report.

PAUL SOLMAN: Meet Harriet Shaw, professional shopper.

HARRIET SHAW: This price increased. It was $5.89 last month and now it's $6.69 per item.

PAUL SOLMAN: It's September 12th, and Shaw is gathering data for the government, price data from which the nation's most prominent index of inflation is computed, the Consumer Price Index or CPI.

HARRIET SHAW: This is $1.29. Last month, it was $1.67. It's not a sale price. It's a new regular price.

PAUL SOLMAN: Does our super shopper stop digging when she finds Preparation H going up and hair spray down?

HARRIET SHAW: No, no. And if it's more than a 10 percent change in price, I have to justify it, so I can question and ask them why it's gone down or why it's gone up.

PAUL SOLMAN: On any given day there are 330 Harriet Shaws in all parts of the country checking prices for the Bureau of Labor Statistics. The monthly CPI figure reflects the annual rate at which those prices seem to be rising.

HARRIET SHAW: And it's $37, and that's what it was last month, so there's been no change in the price.

PAUL SOLMAN: To see how the government determines inflation and how well it does the job, we spent a day in suburban Chicago with Shaw.

HARRIET SHAW: A lot of people are not aware of what the Consumer Price Index is.

PAUL SOLMAN: Well, here's what the Consumer Price Index is: A market basket of goods and services representing the budget of the average American, broken down into seven broad categories. There is housing, the biggest ticket, 41 percent of what we spend; food and beverages, 18 percent of the typical budget of which a third is spent eating out; transportation is also 18 percent; then there's medical, the fastest growing category now up to 6 percent; apparel, 6 percent; entertainment 4 percent; and finally other, the catch-all category that includes both tobacco and education. According to the Bureau of Labor Statistics, that's how we consumers spend our money.

PAUL SOLMAN: But for years, many economists have claimed that government shoppers like Shaw overstate the actual rise in price in three basic ways. Here's the first in an Omni Super Store. Consumers have been flocking to discount stores like Omni and getting lower prices, but the government has just started coming here.

HARRIET SHAW: Well, you select whatever you would purchase if you were the consumer.

PAUL SOLMAN: And what would you purchase if you were the consumer?

HARRIET SHAW: I would purchase something like this, this looks like a good lettuce, as opposed to maybe something that's smaller.

PAUL SOLMAN: The CPI changes the stores it surveys to keep up with consumers. But it switches a lot less quickly than the consumers do. So that's one reason the CPI may be overstated. Possible overstatement number 2, substitution, as when this Omni ran a special on peanuts, a 24 ounce jar for a mere 99 cents.

OLDER MALE CONSUMER: You can't beat that. That's cheaper than the glass is worth. Every time I bought one, the girl said one limit, so I bought one and my wife bought one, so we got two, one from each cashier, and then we got the sales check, went back to the sales check, they had another peanut for the same price, I went back with the cart, come back and got another one. I did that nine times, times two is eighteen. That's what I call a bargain.

PAUL SOLMAN: In other words, bargain hunters may choose to buy far more of a sale item, and, therefore, change what's in their market basket each time they shop. But the CPI assumes we continue to buy the same market basket of goods month after month. Finally, there's a third supposed source of bias. Consider advances in technology that keep delivering consumers more for their money. Here again, the CPI may be missing a drop in the cost of living and thus, overstating it.

HARRIET SHAW: Let me just verify all the information with you. It's a VHS HQ, okay, and the price is $399.95.

SPOKESMAN: $399.95.

HARRIET SHAW: And your sales tax percentage is 7 percent.

SPOKESMAN: 7 percent.

PAUL SOLMAN: The price for the VCR is the same as last month, but the product's been improved. You're spending the same, but you're getting more for your money.

PAUL SOLMAN: Okay. Well, that was our look at the subject in 1991. Now, back to the present, for a debate about the CPI and why it matters. Robert Gordon is a member of the commission that reported its findings today. He teaches economics at Northwestern University. Dean Baker is an economist at the Economic Policy Institute here in Washington. Gentlemen, thanks for coming in. Now, Professor Gordon, why was the commission formed? I mean, what's the big issue driving all of this?

ROBERT GORDON, Northwestern University: There are actually two big issues. One of them has to do with the federal government. We currently use the Consumer Price Index as it's published to decide every year how much to raise Social Security and a number of other retirement programs. We also use the Consumer Price Index to decide how to change the income tax rules; that is, when you go into a higher tax bracket and what your exemption should be. I'm going to give you an example of how important this use of the CPI is. Let's say that we determine, as we reported today, that the CPI overstates the increase in the cost of living by 1.1 percent a year, and let's say that Congress decided that instead of doing what it now does, it was to change the amount by which we adjust these different income tax and benefit programs by the same, 1.1 percent a year. It wouldn't go down. It would just go up slower. Do you know how much difference that would make? In merely 12 years, that would reduce the national debt to $1 trillion. So tonight we're discussing the trillion dollar question.

PAUL SOLMAN: So that's money that would be saved because we pay less--we get less in taxes, and we have high--we don't pay out as much in COLA's, in cost of living adjustments.

ROBERT GORDON: That's right. And this is not a new problem. It's been going on for a long time, and we have had a problem which we're trying to stop in which the elderly beneficiaries of Social Security are being more than compensated for the increased cost of living because of this mistake in the Consumer Price Index, and, as a result, their children and their children's children are going to have to pay higher taxes for all the interest on all that debt.

PAUL SOLMAN: Okay. So, Mr. Baker, this is a big change for people?

DEAN BAKER, Economic Policy Institute: It's a big change. Let me just point out, you know, there's certain logic here that's missing. Let's assume for the moment it's true--and I'd argue strongly I don't think this is true--but let's assume for the moment it is true.

PAUL SOLMAN: That it's being overstated.

DEAN BAKER: That it is being overstated. We're supposed to be concerned about our children and our children's children. This goes exactly the wrong way, because the story here, if we believe this, is that our children and our children's children will be way richer than we thought.

PAUL SOLMAN: Because you mean we aren't really--we don't have the inflation we thought we had?

DEAN BAKER: We have much more rapid growth, so I did the calculations. A typical family income, year 2003, will be over $90,000 a year in today's dollars. Furthermore, let's talk about those--our grandparents on Social Security who are supposed to be the greedy geezers. It turns out most of those people were living below what we would think of as poverty today during their youth because what it means is incomes have been growing more rapidly, people are much poorer than we had thought in the very recent past.

PAUL SOLMAN: But why wouldn't we make the adjustment then, when we'd just all be happy?

DEAN BAKER: Well, it's a question--you're going to be hurting a lot of people. Most elderly, the fact of the matter is their typical income is about $20,000, because they're not wealthy people. So if we cut back their Social Security, they're going to feel a real pinch.

PAUL SOLMAN: What about the elderly? I mean, aren't they actually spend--they are more reliant on Social Security, more reliant on cost of living increases, and they don't have the same market basket the rest of us do?

ROBERT GORDON: First of all, again, nobody is going to cut Social Security. All we're doing is talking about the rate at which it increases. Now, let's say that in 19--

PAUL SOLMAN: So right now it increases at 3 1/2 percent a year because the cost of living again would be 2.4 percent, because you'd take out that 1.1, is that what you mean?

ROBERT GORDON: Yeah. But at some point in the past, about 20 years ago, Congress said we're going to protect the beneficiaries of Social Security from the ravages of increases in the cost of living. But we did more than that because the Consumer Price Index was even more in error in the past than it is today. And so compared to working people who pay taxes, the elderly we have been steadily moving ahead. And so the group in our society that has the smallest incidence of poverty are the elderly receiving Social Security. Now, this generation of elderly recipients has benefitted from the great housing price inflation, 3/4 of retired people own their own homes or condominiums. They've enjoyed capital gains, which we are not including at all. In other words, that actually reduces their cost of living because they have the capital gains that they can apply to other expenditures.

PAUL SOLMAN: You mean, they could sell their house?

ROBERT GORDON: Yes. This generation of people over 65 has benefitted from the great housing price inflation and from the overstatement of indexation.

PAUL SOLMAN: So are the elderly, actually, have they been unfairly benefitted to this point, or are they going to be unfairly disadvantaged by this change, if it occurs?

DEAN BAKER: Well, it's hard to see how they could have been unfairly benefitted, because, keep in mind, let's assume that they're right, that incomes on the whole have been growing much more rapidly than we thought. So what's wrong with the elderly sharing in that? You know, why "shouldn't" they get a share if we're really much richer than we thought? I mean, that's what we're being told here. I don't believe that's true. But if we think it's overstated, we have to think that's true.

PAUL SOLMAN: Well, tell me why you don't think it's true. I mean, we saw the piece. And we've heard his arguments, at least, or his assertions. Why is it not--

DEAN BAKER: Okay. There's clearly some truth to all the things that have been put forward here, but what we have here is there's a lot of cases where we're seeing double counting, we look at substitution, and then we look at the retail outlet issue. There's often double counting in these things.

PAUL SOLMAN: I don't understand that.

DEAN BAKER: Well, suppose we were to look at some substitutions saying, well, people are getting cheaper goods, and we say this is good, the apples over here are cheaper than the oranges over there, but that's also coinciding with the retail outlet issue, that people are buying the apples at a discount store.

PAUL SOLMAN: Well, what about quality? I mean, the quality is a large part of what you claim the overstatement is about.

DEAN BAKER: Quality is very important and very hard to measure. And, in fact, Professor Gordon has done much of the leading work here, and I've looked at his own work, and, in fact, he shows a lot of evidence that the CPI overstated quality adjustments and, in fact, therefore understated the rate of inflation in a lot of goods back in the 70's and 80's.

PAUL SOLMAN: Well, you're right here now, so you can tell us what's the story on quality?

ROBERT GORDON: Well, everybody says, well, couldn't it be an error in the opposite direction? Is it really true that the CPI misses improvements in quality? Haven't they missed other problems that go in the opposite direction? Actually, the CPI's fixed a lot of the downward bias, the error in the opposite direction that we're talking about tonight. They used to understate the increase in prices of apparel. They used to understate the increases in the prices of housing. They used to understate the increases in the prices of automobiles because of the way they treated such items as anti-pollution devices. But in our study, which goes to this in much more detail than anybody has before, we break it out by periods of time. We're talking about what's true right now. They've actually fixed some of the errors that go in the opposite direction. And some new problems are emerging that are very serious, namely, the two most important. Things like the personal computer are getting more important, so they are now noticeably a substantial part of consumption. The prices are going down at 25 or 30 percent a year. And that's even an understatement.

PAUL SOLMAN: But aren't they getting harder to use? They break down more often. I can tell you about my personal computers; they're impossible. So, I mean--

ROBERT GORDON: I'll help you program it tonight after the program.

PAUL SOLMAN: No. But I mean they actually break down.

DEAN BAKER: There are problems with that also. The personal computer use of my own is almost all for business. That's why it's not counted. But there are other areas where they don't look at, for example, insurance, insofar as health insurance premiums go up, the health insurance, the rise in Medicare premiums. That's not even counted in the CPI. That's particularly important when you're talking about Social Security for the elderly, because they're almost sure to see very large increases in Medicare premiums.

PAUL SOLMAN: Isn't your basic argument--I mean I've heard you say this before--that basically the quality of life now is better than it was before, and we're not counting it, is that the nub of what you're saying?

ROBERT GORDON: That's right. And this report today is, if anything, a substantial understatement. We take into account some improvements that we tried to measure. Apartments have gotten bigger. They now have central air conditioning. There's an increased variety of food. There's an increased quality and better reliability of appliances, but there's lots of other stuff that we haven't taken into account that everybody knows is getting better. What about the quality of stereo sound? What about the quality of the color TV picture? What about the increased safety of power tools at home, the improved durability? You know, the average American automobile now lasts almost 50 percent longer than it did 20 years ago.

PAUL SOLMAN: Let me ask Mr. Baker--don't you think the quality of life has improved?

DEAN BAKER: Well, in a lot of ways, it has. In a lot of ways it hasn't. You know, I have to go off to the suburbs to do my shopping. If I go into a retail store, I probably have to wait much longer before I can go and get someone to wait on me. So there's a lot of ways in which we've seen deteriorations. On net, we are getting wealthier. That's not a dispute. The question is how rapidly and how much of that has picked up in the CPI, and I would argue, for the most part, it is picked up in the CPI.

PAUL SOLMAN: And so it's doing a good job, and you just think it's not doing a good job at all?

ROBERT GORDON: No. We've gone through 27 different pieces of the CPI, and it's not doing a good job. We only found seven of them that contained no bias at all. Let me talk to you about the good old days for a minute.

PAUL SOLMAN: Well, very briefly.

ROBERT GORDON: Okay. People say, oh, well, the air is dirty and we have more crime and everything. We looked at all that too. The air is getting cleaner, water is getting cleaner, the crime rates are going down, homicide rates are going down. We looked at almost every different aspect of the quality of life, and longevity has gone up by five years in the last two decades.

PAUL SOLMAN: The last word to you.

DEAN BAKER: There's a popular perception that things are getting worse. Now, it's possible that everyone's wrong, and this commission's right. I'm inclined to believe the CPI and most people.

PAUL SOLMAN: Thank you very much, gentlemen, both.

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