Which Individual Income Tax Provisions Could Be Better Adjusted for Inflation?
Two things that have been front-and-center in the minds of many Americans lately are taxes and inflation. However, few have probably thought about how the two are intertwined — especially in terms of how some provisions in the tax code are adjusted to match inflation, but others are not.
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Basic provisions such as personal income tax brackets and standard deductions are adjusted for inflation, according to the Tax Foundation, an independent, non-profit tax policy organization.
Other provisions adjusted for inflation include the minimum income threshold for the alternative minimum tax; capital gains tax brackets; maximum values of the Earned Income Tax Credit (EITC); limits on the 20% pass-through business income deduction; and the annual exclusion for gifts received. The refundable portion of the Child Tax Credit (CTC) gets adjusted for inflation as well, but not the CTC’s maximum value.
But several other provisions are not adjusted, or indexed, for inflation. The Tax Foundation cites the Net Investment Income Tax (NIIT), which levies a 3.8% tax on investment income for single filers with annual incomes over $200,000, or joint filers with incomes over $250,000.
If you take into account cumulative inflation since the tax was first enacted in 2013, the current NIIT would be expected to apply to single filers making more than $246,000 a year, or joint filers making more than $308,000. Fixing this would be as simple as indexing the NIIT thresholds to inflation and adjusting them as necessary.
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Some tax experts argue that a better tax model in terms of inflation is a “savings-consumption neutral income tax.” Under this model, your income is only taxed when it is consumed, meaning savings are deducted when they are earned and taxed when they are realized. Supporters say this could be achieved by creating universal savings accounts in which all savings would be eligible for 401(k) tax treatment and taxed at ordinary income rates when realized.
Alex Muresianu, a federal policy analyst for the Tax Foundation, wrote that introducing a saving-consumption neutral income tax would address inflation-related issues “more broadly,” especially in terms of capital gains taxes.
“Under current law, taxpayers owe capital gains taxes even if in real terms they aren’t earning any income because their gains are wiped out by inflation,” Muresianu noted. “One proposed fix is adjusting the basis — the value of the original investment — for inflation so the capital gains tax only falls on real increases in income.”
The problem is, fixed-income assets like bonds or annuities are “far more sensitive to inflation” than stocks are, Muresianu added. “Indexing some types of gains, but not others, would create problems…Ultimately, the basic bracket structure of the individual income tax adapts to inflation reasonably well.”
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