Two of the taxes introduced in the Affordable Care Act (ACA) are not indexed for inflationInflation 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. . As incomes rise with inflation, more Americans will be subject to these new and burdensome taxes. This lack of inflation indexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. flies in opposition to the treatment of most other taxes in the ACA as well as many other federal taxA 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. provisions.
The Additional Medicare Tax of 0.9 percent is a payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. and the Net Investment Income Tax of 3.8 percent is a tax on investment income. Each tax applies to individuals over a non-indexed threshold of $200,000 for single filers and $250,000 for married joint filers.
The Additional Medicare Tax of 0.9 percent adds to other payroll taxes: 12.4 percent Social Security tax on income up to $117,000, 2.9 percent Medicare Hospital Insurance tax on all income, and up to a 6 percent tax on the first $7, 000 earned for Unemployment Insurance. The Net Investment Income Tax increases the top marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on capital gains and dividend to 23.8 percent.
By not indexing the income thresholds for these taxes to inflation, individuals and families currently earning below the income cutoff will eventually be subject to these two ACA taxes as inflation increases their nominal wages in the future.
As the prices of goods and services rise over time due to inflation, incomes rise too. If income and the price of goods and services rise at the same rate, an individual or family may appear to have higher income, but they will only be able to purchase the same exact amount of stuff each year. This is because increases in income as a result of inflation do not increase real wealth.
Due to the lack of inflation indexing, the ACA’s $200,000 threshold for taxation will stay the same as incomes increase. Taxpayers will increasingly find themselves subject to the threshold, paying higher taxes, even though they earn the same amount of real income. This phenomenon is called “bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. .” To keep inflation from pushing taxpayers into higher brackets, the federal income tax, social security taxes, other ACA taxes, and more than 40 other federal credits and deductions are indexed for inflation.
Indexing for inflation is important because it allows taxpayers to know what their real after tax income will be in the future. Without inflation indexing, taxpayers face uncertainty about future tax liabilities. For example, the lack of inflation indexing for capital gains taxes can create infinite effective tax rates.
This uncertainty about the real value of future tax payments violates a key principle of sound tax policy. Tax policy should be transparent, stable and not prone to unpredictable swings. Inflation indexing stabilizes real future taxes and ensures predictability.
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