Our federal tax system includes numerous dollar amounts, such as for the standard deduction amount, personal exemption amount, credits, where different tax rates start and end, and defining the parameters of a “small taxpayer.” Some of these amounts are adjusted for inflation and others are not. Should they all be? That’s a good question.
I think where the tax rates of the graduated rate system start and end should be adjusted annually for inflation. This prevents “bracket creep” where a taxpayer is pushed into a higher tax bracket just because their income increased by the rate of inflation (yet their buying power and sense of wealth remained the same). The same logic calls for adjusting the standard deduction and personal exemption amounts.
Our federal income tax is not consistent regarding the need to prevent bracket creep for all taxpayers. The corporate rate structure is not adjusted for inflation. Also, the definition of “small taxpayer” such as a corporation with $5 million or less of gross receipts, is not adjusted for inflation. They should be.
Also, dollar penalties should be adjusted for inflation to ensure they remaining meaningful penalties.
One place where I think inflation adjustments are not warranted is for thresholds for filing information returns. For example, if a business pays a contractor $600 or more for the year, the payor needs to issue Form 1099-MISC. This measure helps ensure that the contractors properly report their income. If the threshold is raised annually for inflation, fewer 1099-MISCs would be filed and the tax gap would increase.
The Tax Foundation has an interesting map showing which states adjust the income tax brackets for the effect of inflation. I’m surprised so many do not adjust. Not adjusting for inflation generally means that the state will collect more revenue each year. Not sure that is the reason some states do not adjust the tax brackets, perhaps their system has just always been that way.
Not adjusting for inflation has caused problems at the federal level for the highway trust fund (see my post of 5/6/14).
What do you think? Should all dollar amounts in any tax system be adjusted annually for the effect of inflation?
Original Post By: Annette Nellen