Home | About Us | Contact Us

MRSC Tools & Resources

• Library Loan Request
• MRSC Index
• MRSC Publications List
• Research Request
• Sample Local Government Documents

Implicit Price Deflator for Personal Consumption Expenditures
Referendum 47's Measure of Inflation

by Tom Sutberry, MRSC Public Policy and Finance Consultant
February 1998

Now that most local policy makers in Washington have had to navigate the uncharted waters of Referendum 47, the question, "What is the implicit price deflator for personal consumption expenditures?" has come up on a number of occasions. This question is important because this new measure of inflation provides yet another limit to growth in the property tax levy for jurisdictions with a population of 10,000 or more. Any of these jurisdictions planning to raise their levy beyond this new measure of inflation must declare a substantial need and then approve the levy with a super-majority council or commission vote. This briefing paper will provide an overview of the implicit price deflator for personal consumption expenditures and compare it as a measure of inflation with the consumer price index.

By way of background, the Washington State Legislature passed Referendum Bill No. 47 on to the voters of the state who in turn approved it by a 60% majority. A section of the referendum, codified as RCW 84.55.005(1), defines inflation as "the percentage change in the implicit price deflator for personal consumption expenditures for the United States as published for the most recent twelve-month period by the bureau of Economic analysis of the federal Department of Commerce in September of the year before the taxes are payable."

Many local policy makers and administrators are familiar with the Consumer Price Index (CPI) as a measure of inflation in relation to employee wage contracts and media reports, but they have had no reason or opportunity to deal with this new measure, the implicit price deflator for personal consumption expenditures, hereinafter referred to as the IPD. The IPD has been previously used as a measure of inflation by the state legislature when it limited growth of the local criminal justice distributions from the motor vehicle excise tax by the same measure. The state Office of Forecast Council has been using the IPD as its main measure of national inflation for a number of years. Its publication, The Washington Economic and Revenue Forecast, includes a history of the IPD as well as annual projections.

What is the US CPI-U?

The CPI measures the average change in prices paid by urban consumers for a fixed market basket of goods and services. It is currently indexed to a base of 100 measured during 1982-84. In 1998 that base will change to 1993-95. The CPI was developed during World War I, when rapid price increases in shipbuilding centers made a cost of living index essential for wages. It is published monthly by the Bureau of Labor Statistics (BLS) of the federal Department of Labor. The BLS calculates the CPI for two population groups, the CPI-W, consisting of wage earners and clerical workers and the CPI-U, consisting of all urban consumers. These indices are also published for various metropolitan areas. By the way, the BLS strongly recommends not using the metropolitan indices for labor contracts because of sampling errors inherent in such small populations. The national or regional CPI measure is far more reliable as an indicator of increases in the cost of living.

The market basket of goods and services measured in the CPI consists of food and beverages, housing, apparel and upkeep, transportation, medical care, entertainment, and other goods andservices. Housing is by far the most important element, having a weight of approximately 40% in the calculation. A rental equivalency is calculated for homeowners and actual rents are tracked.

What is the Implicit Price Deflator for Personal Consumption Expenditures?

The IPD is a nation-wide indicator of the average increase in prices for all domestic personal consumption. It is indexed to a base of 100 in 1992. It is derived from the national income and product accounts' best known summary measure, "gross domestic product"(GDP). The GDP is comprised of four major categories: (1) personal consumption expenditures; (2) gross private domestic investment; (3) net exports of goods and services; and (4) government purchases.

Personal consumption expenditures are defined to include domestic goods and services purchased by individuals, operating expenses of nonprofit institutions serving individuals, and the value of food, fuel, clothing, housing, and financial services received in kind by individuals. The category represented about 68% of GDP in 1996. Housing rental and utility costs represent only about 25% of personal consumption expenditures. Housing purchase costs are located in the category "gross private domestic investment."

What are the Differences between US CPI-U and IPD?

The major differences between the CPI and IPD are: (1) CPI measures price differentials for the same fixed market basket of goods and services over time, whereas the IPD for personal consumption expenditures measures average price changes for all domestic personal consumption for the entire nation; (2) IPD measures are revised after initial publication and the CPI is not; and (3) The IPD for personal consumption has recently tended to measure lower price differentials than the CPI.

The following table compares the CPI-U with the IPD since 1992 through July 1997:

+ Change over the period July 1996 through July 1997 as required by Referendum 47, rather than calendar year averages

# Annual average index with base year 1982-84 as reported on table A4.1, Washington Economic and Revenue Forecast, November 1997

* Annual Average index with base year 1992 as reported on table A4.1, Washington Economic and Revenue Forecast, November 1997

The percentage changes following each index column represent the rate of inflation as measured by each indicator. The last column in the chart represents the percentage difference between the IPD and the U.S. CPI-U rates of change. For instance, the -10% figure for 1993 shows that the IPD, as a measure of inflation, grew at an annual rate that was 10% less than the U.S. CPI-U. Averaging all five figures in the last column produces -11.1%, showing that during the last five years the IPD has grown an average of nearly 11% less than the U.S. CPI-U. Over the last fifteen years the CPI-U and the IPD have grown about equally, with CPI-U annual growth being 0.03% higher than the IPD.

Implications for Cities and Counties

Property tax projections are critical to budget planning in most jurisdictions. Projecting the IPD will be necessary for future budget planning processes and for out-year forecasts. Discerning a relationship between the CPI and IPD, along with an up-to-date trend analysis of the IPD can provide your jurisdiction with up to a two-month advance projection on the IPD measure of inflation for property tax levy limits. MRSC will provide an estimate of the July to July IPD change next August for your budget planning purposes. The Department of Revenue will provide each jurisdiction with the actual figure in mid-October.

Additionally, an argument could be made that, if local governments have to live with the IPD for a measure of inflation that restricts a major revenue source, it may make sense to tie labor contracts to this same measure instead of a measure such as the Seattle CPI that recently has measured higher rates of change for inflation. Remember that a revision in the IPD may take up to three months to become obvious. For example, last July's index number, as initially published in the October of 1997 edition of the Survey of Current Business, was 112.7, and it was revised in the January 1998 edition to 112.8.

Finally, be aware that the rate of growth for both the national CPI-U and IPD is currently slowing. The first four months' data since the July IPD show an annualized trend that is about 30% less than the 1.9% figure used for the Referendum 47 inflation measure for 1998 limits on property taxes. Once again, MRSC will keep you posted on the trend as it develops during the year and give you an estimate for budgeting purposes.

Further Resources

You can keep current with the CPI via the web by visiting the MRSC home page at www.mrsc.org and clicking on the index button at the top of our home page and then clicking on the Consumer Price Index. Additionally, you can go directly to the Bureau of Labor Statistics CPI home page.

See the "Special Report: 1998 CPI Changes" from Personnel News, December 1997, by the Washington Local Government Personnel Institute, for more detail information on the CPI and changes coming in 1998.

Implicit price deflators are published for the entire GDP and all its subcategories every month in the "Survey of Current Business" by the Bureau of Economic Analysis, U.S. Department of Commerce. Call (202) 512-1800 or fax (202) 512-2250 for a subscription to the survey. You can get further information regarding GDP by going to the BEA Web site.

MRSC has developed a web page to keep current on the IPD trend. From our home page, click on the index button at the top and then scroll down to Implicit Price Deflator. For those of you without access to the Internet, please call for further information.

You can read and subscribe to the quarterly Washington Economic and Revenue Forecast by the Washington State Economic and Revenue Forecast Council.