Should Congress Cut the Deficit By Changing the Way it Indexes Taxes for Inflation?

By :: July 7th, 2011

Should Congress use a new measure of inflation to index the tax code? It sounds awfully technical—and it is—but shifting to what most economists believe is a more accurate measure of inflation would gradually raise a substantial amount of new revenue for politicians scrambling to find ways to cut the deficit.

The idea has surfaced in the high-stakes budget negotiations between President Obama and Congress. Government would adopt something called the chained consumer price index (CPI) to adjust programs to reflect changes in the price of goods and services.

The proposal isn’t new—it has been kicking around for decades and appeared last year in budget plans offered by both President Obama’s fiscal commission and the Bipartisan Policy Center.  And it would not only apply to taxes—indeed the most controversial change would affect Social Security benefits. But this is TaxVox, so let’s take a closer look at what this revision would mean for taxpayers.

The income tax is littered with provisions that are indexed for inflation, including the standard deduction and personal exemption, the earned income credit and the refundable child credit, and IRA contribution limits. In addition, the tax brackets themselves have been indexed for inflation since the Reagan era. This important feature prevents bracket-creep, where taxpayers pay higher rates just because their nominal (rather than real, inflation-adjusted) income rises.

Shifting to a chained CPI index would achieve two goals. It would fix a vexing problem with the traditional measure of inflation: The CPI does not reflect the fact that consumers respond to higher prices for one product by substituting another. For instance, if strawberries are very expensive at the farmer’s market this week, I may buy cheaper blueberries instead. And, let’s not kid ourselves, the other purpose is to scrounge some new tax revenues without seeming to raise rates or end popular subsidies.

The Congressional Budget Office figures chained CPI would grow at an average annual rate of 0.25 percent less than the traditional CPI. And the Joint Committee on Taxation projects this change would produce about $60 billion in new tax revenue from 2012 through 2021. But keep in mind that the cumulative decline in measured inflation gradually raises more and more revenue. So while the shift would boost taxes by only about $2 billion in 2014, it would generate more than $12 billion in 2021.

Who’d pay? New estimates by my Tax Policy Center colleague Rachel Johnson suggest that average after-tax incomes would fall by a small amount across the board. Those making less than $10,000 would see no change on average, while those making $500,000 or more would see their incomes fall by 0.1 percent. Everyone else, on average, would end up with 0.2 percent or 0.3 percent less, although those making $30,000 to $40,000 would be hit the hardest.  For all households, the typical tax bill would be about $150 higher in 2021 than it is today.  Her estimates all assume the 2001/2003/2010 tax cuts are extended.

Overall, shifting to the chained CPI seems to be a sensible technical change that is long overdue. But it is little more than a back-door rate increase. I’d much rather see a substantial revenue package that eliminates inefficient tax subsidies.

12Comments

  1. Michael Bindner  ::  5:49 pm on July 7th, 2011:

    The other half of this is the impact on benefits. They can only get away with it by raising benefits at the bottom end – perhaps by shifting from bend points to crediting the employer contribuion at an average wage rather than a match to income – and by raising or eliminating the income cap so that the average is increased. Of course, if you raise too much money from Social Security, people start talking about personal accounts again.

  2. AMTbuff  ::  2:50 pm on July 9th, 2011:

    I have no objection to gradual tax increases coupled with gradual benefit cuts. However I believe that sneaky tax law begets sneaky taxpayers. It’s a basic principle of customer loyalty that a company should treat its customers fairly and never try to deceive them. Government has lost a lot of taxpayer loyalty (aka voluntary compliance) by violating this principle time after time.

    Maybe this proposal is the best we can do in our political climate. If so, that’s sad.

  3. Daniel  ::  11:08 pm on July 10th, 2011:

    If you look carefully at Britain’s 2011 budget, a substantial portion of the savings comes from re-indexing away from the Retail Price Index to the Consumer Price Index.

  4. joseph cummins  ::  4:11 pm on July 11th, 2011:

    i dont understand all this. but let me say this i live on ssi as my only income and i have not recieved an increase in two yrs. so i think the gov. is alot of crar they stated to me and im sure every one on social security that the cost of living has not increased. what bubble do they live in . did they all recieve increases in thier pay over the last two yre .. i bet so fed up.

  5. CA Clarke  ::  5:08 pm on July 11th, 2011:

    Everyone on social security or disability’s meager benefits knows that the current COLA ( Cost of Living Adjustsments) have been stalled not because of lack of inflation , but because gas and other energy products are not taken into account In addition, we live in a monopolistic corporate empire that doesn’t give a damn about COLA so this new CPI adjustment seems to me to rub the figures the wrong way, by the way what is the alternative purchase for totally monopolistic grain and gas purchases .There is none

    Wake up to reality Govt economists, all you’re doing with this watered down CPI index is creating an underclass of retirees instead of dragging your feet over BUSH ERA tax cuts.

  6. ralphfuqua  ::  5:26 pm on July 11th, 2011:

    I thank thay should leve social security alone people are now geting along pertty good with it if thay lower it would be a little rough on older pople that are trying to make a good liveing.

  7. Amanda Mendez  ::  5:31 pm on July 11th, 2011:

    you people in the white house are full of stupidity and are living in another world.one of the way we can help is by all the politician including the president himself to take a pay cut also to stop the benefits that immigrants are getting like medicaid and foodstamps for the kids they have here and because the kids are american born we have to support them that’s bullshit.also to cut ss,my poor husband who suffered and auto accident in 95 and has not been able to work and is receiving his benefits and haven’t seen an increase in over 3 yrs,I have had to work 7 days a week to provide for our kids still have 2 in college and barely have enough to buy food it’s outrageous,we file bankruptcy and lost our home,my poor son has to take out loans and work full time to at least have enough to make through the semester,my daughter also works full time as well my kids are suffering because my goverment can’t help and my kids have to go through the burden of helping me and their dad financially because you all think it’s better to cut benefits stop the benefits from these illegal immigrants.I’m a shame to be called an american because we don’t take care of our own.

  8. Julia Langdon  ::  6:13 pm on July 11th, 2011:

    So they know that after 2 years of not giving Social Security beneficiaries any cost-of-living increase, they won’t be able to avoid it next year. And now they want to scrap the formula used to get out of giving even a $12/month increase to the elderly and disabled? Wow. How low can you possibly get?

    I figured Obama was inept but I didn’t peg him for being sleazy. My mistake.

  9. The AUricle  ::  6:44 pm on July 11th, 2011:

    This is just more INSANITY.
    SS receipients are already being screwed by the wya Gov’t ‘calculates,’ or should I say, fudges on the true inflation numbers. The under-reporting of inflation is costing seniors multiple percent per year. Just ask one. The cost of EVERYTHING is up FAR MORE than the COLA increases, and this will make it even worse.
    “Substitute blueberries for higher cost strawberries”???????….HAHAHA….what a joke!!

    Let’s see, maybe we can substitute sawdust for gas in our cars too.
    Or how ’bout going to your local dumpster for dinner, instead of actually BUYING FOOD to eat. Yeah, that should lower inflation!

    These people are SERIOUSLY sick in the head, and WE better take over control of this situation, or else we’ll all be lining up for scraps from their tables….

    Seriously, you want to generate more revenue for SS, tax EVERY dollar of income…NO LIMIT for people earning over the ‘maximum’ to contribute. Had this been done 20 years ago, we wouldn’t be in this ‘crisis’…….but that’s too ‘easy’ and fair for these assholes to see!

  10. Georgia Joe  ::  8:38 pm on July 11th, 2011:

    So, if I understand this, the middle-class, mid-level earners in the country pay for the bulk of the new program. And this is considered fair?

    Like one of the posters before me, I believe the fastest way to stop the slide in SS funding is to cease the SS contribution ceiling, and have those earning in the upper reaches of income contribute at the same rate as any lower-wage earner, regardless of how high their income is. The cutoff now is far too easy on the wealthy, and yet they are the first to complain about how much of their income is diverted to government functions. Don’t they also like to drive over safe bridges, have operating sewer systems, etc?

  11. Bill S  ::  9:04 pm on July 11th, 2011:

    The government doesn’t recognize inflation the right way as it is. It shouldn’t change it more to understate future inflation. If the price of strawberries goes up it should be properly accounted for in the inflation rate. Food prices have increased 30% in the last year. According to shadowstats.com, real inflation is about 9% right now.

  12. SSdogsoldier88  ::  9:04 pm on July 11th, 2011:

    repeal the windfall elimination provision…it is a lie, it discriminates, it is cruel and unusual punishment, it is financial slavery, it promotes false imprisonment…it is age discrimination.