Pay raises are not keeping up with inflation
Recent pay hikes still aren’t keeping up with the cost of living.
Buzz60, Buzz60
Inflation itself is effectively a tax on goods and services – and with the rate of rising prices at a 40-year high, that tax is weighing on Americans’ wallets. And on top of that, Americans are set to pay more taxes because of it.
Since 1981, federal income tax brackets have been indexed to inflation. That came after record levels of inflation in the 1970s.
If income tax brackets weren’t indexed to inflation, Americans would be subject to higher tax rates for raises they received, in some cases to keep up with inflation. But the real value of the higher salary, meaning how much you can buy with it, doesn’t change.
So getting taxed at a higher rate because of the raise may mean that the value of your post-tax income is even lower than it would have been had you not received a raise.
But not all states do this. In fact, 15 states and Washington, D.C., don’t index their income tax brackets to inflation.
“It’s basically giving the government a bonus for having inflation,” said Richard Kaplan, a tax law professor at Illinois College of Law.
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That’s just one of the ways inflation penalizes taxpayers.
And because inflation’s impact on taxes isn’t easily discernible by most taxpayers, lawmakers at state, local and federal levels aren’t in a rush to ensure everything is properly indexed to inflation, said Matt Gardner, a senior fellow at the Institute on Taxation and Economic Policy, a nonpartisan think tank.
“It’s just not something that lawmakers get a big payoff for thinking about,” he said. “It’s the least sexy element of an already unsexy topic.”
Social Security
While Social Security payments themselves are adjusted for inflation annually, the taxes recipients pay on them is not.
Since 1993, 85% of Social Security payments each year is taxable if your adjusted gross income, which includes Social Security payments, is more than $34,000 for individual filers or $44,000 for people filing jointly. And 50% of Social Security payments are taxable if your income is between $25,000 and $34,000 for individual filers and between $32,000 and $44,000 for joint filers.
When Congress passed a law in 1983 that made Social Security payments taxable, less than 10% of beneficiaries paid federal income tax on their benefits under the income thresholds at the time, according to a 2015 report published by the Social Security Administration.
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But given that the income thresholds haven’t been updated since 1993, some “56% of beneficiary families will owe federal income tax on part of their benefit income from 2015 through 2050,” according to the report.
Most Social Security recipients are subject to the 50% tax, Gardner said.
“So it’s not like this is a huge surtax,” he said.
But nevertheless, without indexing the income thresholds, Congress is “implicitly agreeing” to impose higher taxes each year on Social Security recipients, he said.
State and local tax deductions
Before the Tax Cuts and Jobs Act went into effect in 2018, taxpayers who itemized their returns had no limit to state and local tax deductions. But once the law went into effect, there was a $10,000 cap on SALT deductions. That threshold hasn’t changed since.
“By some arguments, that’s already a very low deduction amount and then it’s additionally not being indexed for inflation,” said Bridget Stomberg, an accounting professor at Indiana University’s Kelley School of Business.
If the SALT deduction increased, “there are a lot of taxpayers” who would benefit because they’re paying more as home prices are increasing along with property taxes and incomes, she said. Some states offer workarounds to ease the tax burden people face from the cap in the form of an effective tax break on certain businesses.
Standard deductions and personal exemptions
The federal standard deduction is adjusted every year for inflation. This year, it amounts to $12,550 for individual filers, $25,100 for spouses filing jointly and $18,800 for heads of households. However, 11 states and Washington, D.C., don’t index their standard deductions to inflation.
The remaining states either don’t tax income, don’t have a standard deduction or index it to inflation.
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Similarly, 19 states don’t index their personal exemptions, according to an analysis published by the Tax Foundation. At the federal level, there no longer is a personal exemption. But when there was one before the TCJA went into effect, it was indexed to inflation.
“If people’s incomes go up, the correct response is to hold everyone harmless,” Kaplan said. By not indexing to inflation, taxpayers end up owing more money than last year if their incomes increased and the deductions or exemption figures haven’t been updated to reflect higher inflation.
“All they have to do is basically conform to what the feds are doing. They don’t have to invent any wheel.”
Life insurance premium taxes
Some 60% of workers had access to a life insurance plan through their employer last March. Of these workers, 98% took the life insurance.
As it stands, the first $50,000 of coverage isn’t taxable, but anything above that is. That threshold was set in 1964 and hasn’t been updated. Back then, the median family income was around $6,600, according to the Census Bureau.
But since employers often offer life insurance coverage equivalent to one to two times a person’s salary, many workers end up having to pay taxes, Kaplan said. That’s applicable to most Americans since the average worker now earns around $57,000 a year, according to the Bureau of Labor Statistics.
The taxes they pay for what’s officially known as “excess life insurance” will increase every year as the policyholder gets older and as salaries continue to rise, Kaplan added.
Follow Elisabeth Buchwald on Twitter at @BuchElisabeth.