‘Hidden tax increase’ is neither hidden nor an increase

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The “Big Six” tax reform plan has generally earned well-deserved plaudits for being a framework that aims to restore some sanity to the nation’s tax code. A recent Politico poll shows that Americans are generally receiving tax reform positively.

However, a line that has continued to pop up in recent weeks has been that there is a “hidden tax increase” in the framework. Think tanks across the spectrum have raised concerns about shifting the current Consumer Price Index (CPI) to a “chained CPI” for income tax brackets. Yet these kinds of labels misrepresent the context of such a shift, making them somewhat misleading.

{mosads}Income tax brackets are indexed to inflation to avoid what is referred to as “bracket creep,” or tax filers being slowly shifted into higher tax brackets despite no increase to real incomes.

 

Congress recognized that Americans should not have their tax rates increased simply because inflation was steadily increasing the amount of money they had, even if that money held less purchasing power.

Congress therefore indexed income tax brackets to CPI. However, this was an imperfect measure of the effects of inflation. When a good’s price increases, consumers are not forced to continue purchasing that good — they often instead “substitute” that good with another like it that has seen a smaller increase in price.

For example, if the price of butter increases, consumers may choose to purchase margarine instead. The ability for consumers to substitute goods in this way lessens the impact of inflation on a consumer’s purchasing power. Chained CPI takes the impact of substitution on a consumer’s purchasing power into account.

For this reason, chained CPI has the long-term effect of reducing the income levels of tax brackets relative to the traditional CPI, which is why some groups label it a “tax increase.”

But chained CPI would not be instituted as a stand-alone measure, but in the context of broader tax reform legislation with other reductions in burdens that more than offset any changes to inflation measures. Under the Big Six framework, chained CPI would be enacted along with a substantial tax cut for the middle class.

Additionally, it is only a “tax increase” in the sense that taxpayers are currently receiving the benefits of an inaccurate measure of inflation. The purpose of indexing income tax brackets to inflation was never to provide a tax cut, it was to ensure that taxpayers were not unfairly having their tax rate increased because of inflation. Chained CPI accomplishes this objective more accurately.

Furthermore, consolidation of the number of tax brackets will lessen the impact of bracket creep. Taxpayers were far more likely to be shifted up a bracket when there were seven brackets with smaller thresholds. Under the Big Six framework, there would only be three brackets, making the incidence of bracket creep less common. 

Finally, it is important to note the potential benefit of setting a precedent of using chained CPI for the spending side of the ledger as well. Just as chained CPI is more accurate for the purposes of accounting for inflation with income tax brackets, it is also more accurate for cost-of-living adjustments for government benefits.

Setting income tax brackets to a chained CPI for income tax brackets could result in ensuring that the government is not over-accounting for inflation in other areas as well, having the effect of reducing outlays somewhat. 

Claims that the implementation of a chained CPI represents a “hidden tax increase” miss out on some important points. It is a more accurate measure of inflation, performing the goal of accounting for adjustments in the dollar’s purchasing power more effectively.

Congress should not fear moving toward a more accurate system of measuring inflation, particularly in the context of a fundamental tax reform plan that simplifies and lowers taxes for many.

Andrew Wilford is an associate policy analyst at the National Taxpayers Union, which advocates for lower taxes and smaller government on all levels. 

Tags Consumer Price Index cost of living economy Economy of the United States Income tax in the United States Inflation Macroeconomics Price indices

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