Federal income tax is generally adjusted for inflation. In particular, the income brackets to which the marginal tax rates apply increase according to the “chained CPI-U”. While the chained CPI-U has risen somewhat less rapidly than the headline CPI-U or CPI-W used to adjust Social Security benefits, the adjustment will be significant (see Table 1).
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Federal personal income tax brackets vary by household type — single, married, head of household. Table 2 shows the 2022 brackets for married households. Assume that the chained CPI for calculating the 2023 brackets increases by 8%. then the dollar limits in Table 2 would all increase by 8%. As a result, low-income couples will remain in the 10% bracket until their income exceeds $22,200, and high-income couples will not be subject to the 37% rate until their income exceeds $699,700. In addition, the standard deduction for married couples will increase by 8% from $25,900 to $28,000.
While indexation ensures that workers whose earnings rise by 8% are not hurt by inflation, and those whose earnings are less than 8% actually see their tax bill fall, this is not the case for pensioners. Because the provisions for taxing Social Security benefits do not adjust at all for rising prices, inflation results in higher taxes for beneficiaries.
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Under current law, married couples with less than $32,000 in modified adjusted gross income (AGI) do not have to pay taxes on their benefits. (“Modified AGI” is AGI as reported on tax forms plus tax-free interest income, foreign-source interest, and half of Social Security benefits.) Above this limit, recipients must pay up to 50% in taxes or 85% of their benefits (see Table 3).
Unlike the rest of the federal income tax, the thresholds for calculating Social Security taxes are not adjusted for inflation. As a result, if the CPI-W in the third quarter of 2022 exceeds that of the third quarter of 2021 by, say, 9.5%, the 2023 cost of living adjustment will force many who do not currently pay tax on benefits them to include 50% in their calculations and many others who only include 50% pay taxes of up to 85%. That is, many retirees will see a tax increase.
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The bottom line is that high rates of inflation will allow many workers to enjoy a reduction in their tax burden, while forcing many retirees to pay more.
My point is that virtually everything in the world of politics should be adjusted for inflation.
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