October 8, 2007

Inflation Adjustments for Tax Brackets Will Be Significantly Smaller in 2008 than in 2007

Gerald Prante

Gerald Prante

Download Fiscal Fact No. 105

Fiscal Fact No. 105

While the Internal Revenue Service does not officially release its inflation adjustments for Tax Year 2008 until December, they will base the adjustments on the average of the Consumer Price Index from September 2006 to August 2007. The final August 2007 number was recently released by the Bureau of Labor Statistics. The relevant inflation rate for Tax Year 2008 based on the average CPI values over the past 12 months is 2.29 percent, which is significantly smaller than the change that occurred last year, which was nearly 4 percent. Table 1 looks at the changes in various recent tax years.

Table 1: Inflation Tax Adjustments Have Varied Widely over Past Ten Years

Old Tax Year – New Tax Year

Change in Average CPI

Tax Year 1998 – 99:

1.69%

Tax Year 1999 – 00:

1.82%

Tax Year 2000 – 01:

3.11%

Tax Year 2001 – 02:

3.29%

Tax Year 2002 – 03:

1.59%

Tax Year 2003 – 04:

2.28%

Tax Year 2004 – 05:

2.30%

Tax Year 2005 – 06:

3.11%

Tax Year 2006 – 07:

3.90%

Tax Year 2007 – 08:

2.29%

Bureau of Labor Statistics; Tax Foundation calculations

Below we present a projection of the most important parameters in the federal individual income tax system for Tax Year 2008, and we compare them to Tax Year 2007, for which tax returns will be filed in spring 2008 (April 15th deadline). Current tax year is in parenthesis.

Table 2: Tax Year 2008 Will See Small Change from 2007 Due to Inflation

Key Tax Variable

Single Filers

Married Filing Jointly Filers

Married Filing Singly Filers

Head of Household Filers

Personal Exemption

$3,500
(3,400)

$3,500
(3,400)

$3,500
(3,400)

$3,500
(3,400)

Standard Deduction

$5,450
(5,350)

$10,900

(10,700)

$5,450
(5,350)

$8,000

(7,850)

15% Bracket Kicks In

$8,025
(7,825)

$16,050
(15,650)

$8,025
(7,825)

$11,450

(11,200)

25% Bracket Kicks In

$32,550
(31,850)

$65,100
(63,700)

$32,550
(31,850)

$43,650

(42,650)

28% Bracket Kicks In

$78,850
(77,100)

$131,450

(128,500)

$65,725
(64,250)

$112,650

(110,100)

33% Bracket Kicks In

$164,550
(160,850)

$200,300

(195,850)

$100,150

(97,925)

$182,400
(178,350)

35% Bracket Kicks In

$357,700
(349,700)

$357,700

(349,700)

$178,850
(174,850)

$357,700

(349,700)

Source: Bureau of Labor Statistics; Tax Foundation calculations; and James C. Young, “Inflation Adjustments Affecting Individual Taxpayers in 2006: Analysis and Commentary,” Tax Analysts Special Report, Oct. 3, 2005, available at http://taxprof.typepad.com/taxprof_blog/files/2005-19011-1.pdf.

How much will this inflation adjustment save people? Assume we have a single filer who makes $50,000 in both 2007 and 2008 (i.e. he receives no pay increase) and he takes the standard deduction and has no dependents. In 2007, that person would pay $6,736.25. In 2008, he would pay $6,606.25. Compare that to 2006, which gave us a very large inflation number, and the person earning $50,000 would have been paying $6,945.

These automatic, annual bracket adjustments were enacted as part of the so-called Reagan tax cut in 1981 but with a four-year delay so that they didn’t start until 1985. They can amount to an invisible, annual tax cut, or merely keep a person’s real tax bill the same. Before 1985, the opposite occurred each year. A large, annual tax hike occurred as inflation pushed people up into higher tax brackets even if their purchasing power hadn’t increased at all. Bracket levels were never adjusted unless Congress passed a tax law, and with inflation as high as it was during the 1970s, those annual tax hikes were huge. However, not all tax parameters are adjusted for inflation. The child tax credit amount of $1,000 is not adjusted, and the AMT exemption amounts are not annually indexed for inflation.

Conclusion
The time period of September 2006 through August 2007 had relatively mild inflation compared to the previous two periods, resulting in much smaller inflation adjustments for tax year 2008 than we saw in the previous two adjustments.

Note: For a complete detail of this complicated adjustment process, see Prof. James C. Young’s article last year on the topic, available here.

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About the Author

Gerald Prante

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

Inflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.

A tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat.

The standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes.

An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.