Income Tax Reform Must Include Automatic Bracket Adjustments
Hopefully, next week's tax reform bill will include automatic annual increases in tax brackets, not just a one-time increase.
For years, the Utah Taxpayers Association has been advocating for annual inflationary adjustments to individual income tax brackets. Nearly every year for the past ten years, the association has held a press conference on Tax Day, April 15th, in front of the Utah State Tax Commission in order to call attention to the indexing problem. Radio, TV, and newspapers (except for the Tribune) have always covered the event.
Without bracket adjustments, effective tax rates increase over time because, as wages increase due to inflation, more and more income is taxed at the highest marginal rate. While lack of indexing harms nearly all taxpayers, low and middle income taxpayers are impacted the most as a percent of income. (However, taxpayers with zero, near-zero, or exceptionally low taxable income typically do not benefit from indexing.)
For example, a typical 2-parent, 2-child household with AGI of $40,000 in 2005 had an effective tax rate (ETR) of 2.97%. Had brackets been indexed for inflation since 1973, the ETR would have been 1.70%, a 43% reduction.
The same household configuration with AGI of $200,000 in 2005 had an ETR of 5.12%. Had brackets been indexed, the ETR would have been 4.78%, a 7% reduction.
While nearly all households would have lower tax burdens if tax brackets had been indexed every year since 1973, lower and middle income households would have received the largest tax breaks in percent terms.
In the 1970s, "bracket creep" was a household term in the U.S. because the federal government did not automatically index federal tax brackets for inflation. As a result, effective tax rates increased, especially during periods of high inflation. The term is not widely used any more because the feds began indexing tax brackets more than twenty years ago. However, Utah has made only one adjustment to tax brackets since 1973, a 15% increase in 2001 sponsored by Sen. John Valentine. In 1973, the top marginal tax rate kicked in at taxable income of $7,500. Today, the top rate kicks in at taxable income of $8,626. If tax brackets had been adjusted continuously for inflation since 1973, the top rate in 2005 would apply to taxable income in excess of $32,990. The annual tax increase due to NOT indexing is not very large, but the small increases add up over time.