Is Inflation Lowering Your Taxes?
Annually the IRS adjusts over 60 different tax provisions for inflation to prevent individuals and families from paying more money in taxes while not truly expiring real income growth. As an aside, the IRS also does not adjust every tax provision for inflation. Some provisions are designed to capture more tax income over time — see the infamous Net Investment Income Tax (NIIT)
Understanding C-CPI
In 2018, the IRS moved away from using a standard inflationary measure of the Consumer Price Index (CPI) and started using the Chained Consumer Price Index (C-CPI). The chain-weighted CPI, or chained CPI, is an alternative measurement for CPI and considers changes to consumer spending patterns to provide a more accurate picture of the cost of living based on the goods consumers buy. Essentially, the formula uses a statistical measure of how a price change alters consumption patterns due to the price change. Confusing right?
In a basic example, suppose pork and beef are two separate categories. If the price of pork increases while beef does not, a rational consumer might buy more pork to feed their family. The C-CPI-U is designed to account for this consumer substitution between CPI item categories.
The Impact on Taxes for 2023
Using the C-CPI numbers from above, every October, the IRS releases the updated tax brackets for the following year. These changes are barely noticeable in standard years, and most times, only the tax world cares about them. However, with record inflation being the top news story throughout 2022, the rate shift is far more noticeable, to about 7%.
The chart below shows the change from year over year to the top taxable income threshold in each bracket. Remember, we have a marginal tax system in this country which means that you need to “fill the bucket” with income before moving to the next bracket, where your remaining income is taxed at the next rate. The top bracket for 2023 will remain 37% and start for income higher than $578,125 ($693,750)
Top Marginal Income Threshold Per Tax Bracket
Further giving a boost to taxpayers next year, the standard deduction will increase to $27,700 for married filing jointly and $13,850 for single filers.
While inflation has impacted many, data shows that those impacted the most by rising prices on everyday goods tend to be individuals and families in the lower tax brackets. These changes will likely not affect the tax rates of individuals who have seen salaries or incomes increase due to cost of living adjustments. For many who haven't seen these adjustments, the one glimmer of good news is that your tax bill should likely be less in April 2024.
The increase in tax rates hasn't been the only governmental response to inflation in the past week, as the Social Security Administration announced an 8.7% increase in benefits. The increase in benefits is the most significant single-year increase in individual base benefits since 1981.
All of this comes at the heels of one of the most costly couple of years for the federal government as it combated the COVID-19 pandemic and the social security administration updated its calculations to one year sooner about when the proverbial "well" will run dry (now estimated 2035).
Sources:
Internal Revenue Servcies / US Bureau of Labor & Statistics / The Tax Foundation.org / The New York Times / Yahoo Finance
