Column by Alexis Leondis: Why are there only a few inflation-adjusted tax benefits? | Columnists


By Alexis Leondis

IIn the late 1970s and early 1980s, inflation emerged through what is known as range drift. Because income thresholds for different tax rates were not periodically adjusted for inflation, millions of Americans paid higher rates while their actual incomes remained the same.

The tax cuts initiated by President Ronald Reagan took care of that. Since 1985, the IRS has taken inflation into account each year when announcing income thresholds for the upcoming tax year.

Yet, while dozens of tax provisions are now adjusted for inflation each year, there are still many important ones that do not receive the same treatment.

Take two popular tax breaks: the child tax credit and the credit taxpayers get to help pay for child care costs. Both are lump sums that do not take inflation into account.

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Similarly, the amount a person can write off for an investment loss has been stuck at $3,000 per year since 1978. And the deduction for business gifts has been set at $25 since 1962.

Unfortunately, whether a tax provision is adjusted for inflation depends on whether lawmakers believe there is enough money to authorize it when they write legislation. More often than not, measures to adjust for inflation are the first to disappear during negotiations in Congress, and then they are easily forgotten. We end up with a US tax code that is a total hodgepodge.

Sure, gas prices could come down, but annual inflation remains north of 8% and food prices are still high. When inflation is high, these adjustments are all the more important as they increase the value of tax credits and deductions. Without them, the tax benefits effectively remain stable as everything else becomes more expensive.

Another way things get skewed is when the income thresholds for qualifying for certain tax credits and deductions, as well as those that trigger certain taxes (such as net investment income tax), don’t follow the rate of inflation.

For example, net investment income tax liability thresholds, which subject the highest earners to tax on investment income to help pay for health insurance, have been in place since 2013. $200,000 for single taxpayers and $250,000 for married filers jointly. Adjusted for inflation, those thresholds would now be $257,000 and $322,000, respectively, according to the Tax Foundation‘s Alex Muresianu.

Returning to the Child Tax Credit, a helpful example from the Urban-Brookings Tax Policy Center shows how the lack of inflation adjustments can add up over time. If the current $2,000 credit stays the same, by 2032 it will be worth just $1,430, based on the Congressional Budget Office’s inflation projections.

As a reminder, the child tax credit was increased as part of the 2017 tax overhaul to compensate for the end of the personal exemption for dependents. This was the amount of money that taxpayers used to exclude from their income to have children. The personal exemption was adjusted for inflation, while the maximum child tax credit amount is not.

The child tax credit has been increased again during the pandemic to help low-income families. But that increase expired at the end of 2021. So households that suffer the most get less and they have no inflation adjustment to cushion the blow.

It’s a similar story for deductions for interest paid on student loans. While the income limits for deducting this interest are adjusted each year for inflation, the maximum deduction – $2,500 – is not and has been in place since the early 2000s. student loans have been frozen since March 2020 due to the COVID-19 pandemic.)

The booming housing market has also raised questions about why the amount homeowners are allowed to exclude from their taxes when selling a primary home has been stuck since 1997 at $250,000 for single taxpayers and $500 $000 for married persons filing jointly.

A report from the Congressional Research Service points out that the average sale price of an existing home has increased by 151% since then. CRS has suggested that lawmakers consider indexing these figures to general inflation or housing prices.

There are some tax issues where the argument for automatic inflation indexing is more complicated. Under the current system, capital gains are not indexed.

So when someone sells a stock or a house for profit, the original purchase price is not adjusted for inflation. Such a massive change would lead to a large budget deficit and disproportionately benefit the wealthiest taxpayers.

But there are plenty of other places in the tax code where an annual nod to inflation would be an easier lift. If lawmakers are looking to make higher prices more bearable, one of the most practical ways to start would be to adjust for real inflation.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. She previously oversaw tax coverage for Bloomberg News.

© 2022, Bloomberg L.P.

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