HENDERSON: Inflation's 'Bracket Creep' Puts People in Higher Tax Brackets – Even If Your Income Level Hasn’t Budged

By David R. Henderson

Before 1985, inflation in the United States put people in higher tax brackets even if their real income — discounting inflation, that is — hadn’t budged. The term we used at the time was “bracket creep.” During the Jimmy Cartet years, 1977 to 1981, inflation averaged 10% a year and bracket creep became bracket gallop.

As a result, the U.S. government took an increasing share of people’s income without ever having to explicitly raise tax rates.
 
Although the absolute increase in taxes due to bracket creep was higher for higher-income people, it disproportionately hurt low-income people. The reason: The income range for tax brackets is typically smaller for lower-income filers than at the higher end, and so it’s more likely for low-income people to be pushed into higher brackets.
 
Fortunately, in 1981, Congress passed, and President Reagan signed, a bill that cut tax rates for the next three years, 1982 to 1984, and indexed the tax brackets for inflation from 1985 on. That way, inflation alone can’t put people in a higher federal tax bracket. Only an increase in real income can do that.
 
Unfortunately, a number of state governments have not followed the federal lead.
 
While many state governments have indexed their tax brackets for inflation, the Tax Foundation, a Washington organization that follows taxes closely, notes that many have not. The states that don’t index for inflation are, in alphabetical order:
 

1. Alabama
2. Connecticut
3. Delaware
4. Georgia
5. Hawaii
6. Kansas
7. Louisiana
8. Maryland
9. Mississippi
10. New Jersey
11. New Mexico
12. New York
13. Oklahoma
14. Virginia and
15. West Virginia

Also the District of Columbia has not indexed for inflation.
 
The Tax Foundation gives an example of what would have happened to someone in a hypothetical state with no indexing between 1979 and 1999 with taxable income of $50,000 (in 2019 dollars).

The analysts assume tax brackets that are typical of those in many states, ranging from 3% for the first $10,000 in income to 7% on income above $40,000. Their calculations show that the person’s average income tax rate, also called the effective rate, starts at 3.3% in 1979 and zooms to 4.2% in 1999 — a 27% increase.
 
And remember that most of the years between 1979 and 1999 had inflation rates of 3% or less. The effective tax rate would have risen much more if inflation had been in the 7 to 8% range that the country is now experiencing.
 
This isn’t a typical blue state/red state story in which the red states have better tax policy. Six states — Alabama, Kansas, Louisiana, Mississippi, Oklahoma and West Virginia — are clearly red.
 
Many state governments are flush with budget surpluses. Now is the time to hold the legislatures’ feet to the fire and get them to index tax brackets.

Today's IPI TaxByte was written by David R. Henderson, a research fellow with the Hoover Institution at Stanford University.