Switching from RPI to CPI is even more of a disadvantage than we thought

02 Mar 2012, by Richard Exell in Society & Welfare

Pensioners, carers, disabled and unemployed people are losing even more from changes to the way inflation is calculated than we thought. Unions have been complaining about this change continually since it was first announced just after the general election, but it turns out that we haven’t been making enough fuss: some of the poorest people in the country are going to be losing twice as much as we thought.

Soon after the election, the government announced that it was going to change the way inflation is calculated for the annual increases in pensions and other benefits. Instead of the Retail Price Index, they now use the Consumer Price Index. This sounds rather boring and technical, but, as I’ve noted before, over a number of years, the change will make a big difference to pension levels and the rates of other benefits.

For individuals, that eventually means much lower incomes (ask pensioners what they think about Mrs Thatcher’s decision to switch from raising benefits in line with earnings to raising them in line with inflation.)

For society, it means that the poorest people – those who have to live on benefits for a long time – fall further and further behind the rest of us.

Until now, I’ve been working on the assumption that the average difference between the annual rate of inflation calculated using CPI and using RPI is about 0.7percentage points. Take two people whose pension or other benefit was £10,000 a year in January 2012, uprated each January, one by CPI the other by RPI. The difference may only be 0.7% a year, but by 2036, while the first has risen to £16,084 the second has reached £18,954 – 17.8% more.

But it turns out that this is probably a huge under-estimation of the problem. The OBR has published a useful paper on The long-run differences between and RPI and CPI inflation, which suggests that “the long-run difference between these measures may be significantly higher in the future.”

The OBR initially expected the difference to be half a percentage point higher – 1.2% – but this working paper estimates that it will be 1.3 to 1.5 points – for the OBR’s November Economic and Fiscal Outlook they assumed a 1.4 point difference. This is massive. Look at the impact on the same example as before:

By 2036, the claimant uprated by CPI will get a bit over £16,000. The claimant uprated by RPI will receive more than £22,000 – 39% more.