I have heard over the years that the CPI does not include taxes as one of its components. In other words, an increase or decrease in a tax rate is not considered a change in consumer prices/costs. Is this true? If so, how is this omission justified?
That is a great question. And the answer is quite simple. First of all, according to the U.S. Bureau of Labor Statistics (BLS)- the CPI is not a cost of living index. According to the BLS, “A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or standard of living. Both the CPI and a cost-of-living index would reflect changes in the prices of goods and services, such as food and clothing, that are directly purchased in the marketplace; but a complete cost-of-living index would go beyond this role to also take into account changes in other governmental or environmental factors that affect consumers’ well-being. It is very difficult to determine the proper treatment of public goods, such as safety and education, and other broad concerns, such as health, water quality, and crime, that would constitute a complete cost-of-living framework.”
In other words, the CPI is a Consumer Price Index and designed to cover consumer goods but not all costs of living. Interestingly it does cover, the following (These are the major categories it actually covers over 10,000 individual items):
- FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
- HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)
- APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)
- TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
- MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)
- RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);
- EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);
- OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).
So some intangibles are included like education and medical care but not things like income taxes which are different for each person because their income is different. And income is not correlated to consumer prices in any tangible way.
But all that being said, some taxes are actually included in the Consumer Price Index. Taxes that are directly related to the cost of goods and services are included. Once again, according to the BLS, Included are… “taxes that are directly associated with the purchase of specific goods and services (such as sales and excise taxes). Government user fees are also included in the CPI. For example, toll charges and parking fees are included in the transportation category, and an entry fee to a national park would be included as part of the admissions index. In addition, property taxes should be reflected indirectly in the BLS method of measuring the cost of the flow of services provided by shelter, which we called owners’ equivalent rent, to the extent that these taxes influence rental values. Taxes not directly associated with specific purchases, such as income and Social Security taxes, are excluded, as are the government services paid for through those taxes.”
Also because taxes are such a big component of motor fuel costs the BLS includes those taxes in the cost of gasoline. “The prices collected are classified as a per-gallon pricing unit and include all taxes, both excise and sales taxes.“
So as you can see it is not correct to say that the Consumer Price Index doesn’t include taxes. It does include a factor for taxes related to consumer goods such as sales taxes, property taxes, excise taxes and even toll charges and federal user fees but it doesn’t include all taxes like income taxes and Social Security Taxes.
I hope this helps explain it.