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58 IRET Congressional Advisory 1 (1997)

handle is hein.taxfoundation/iretcgadv0055 and id is 1 raw text is: April 28, 1997 No. 58 WATERING DOWN TAX INDEXING IS BAD ECONOMICS Washington is fixated on the budget deficit to the exclusion of good public policy and sound economics. Members of Congress who would never dream of voting for an across the board increase in average and marginal tax rates on workers and savers are rushing to embrace the same thing in the guise of fixing the consumer price index to help balance the budget by 2002. Those who support an ad hoc CPI change need to reflect on the economic and public policy consequences, and to find a better way to end the budget Even f infla deficit. deficitrattes would i Tax indexing increases the capita real in personal exemption, standard gaduated tax deduction, and the income adjustedfor n levels that separate the it will e..e marginal income tax rate incentives for brackets each year by the growth. growth of the consumer price index. If these amounts were not adjusted, workers whose wages barely kept pace with inflation would find more and more of their income subject to tax each year at the tax rate imposed on additional income in their tax bracket. Their average tax burdens would rise faster than their incomes. Savers whose assets barely rise in line with prices would also find their returns taxed more heavily. Furthermore, each year, lionl I se ov. come rate s (al ill Itulallj . furl some taxpayers would find their incomes spilling over into the next highest tax bracket, raising their marginal tax rates as well. The marginal tax rates are what govern the incentives to work and save to earn additional income. As people rise through the tax brackets, they tend to work less and take more leisure, save less and use more income for consumption. Economic activity suffers when marginal tax rates creep upward, a lesson that became painfully obvious during the bouts of double digit inflation of the 1974-1981 period. Some policy officials and economists have protested that the CPI overstates inflation, that the adjustments of the exempt amounts and tax brackets are too big, and that the government is losing tax revenue. Budget makers want the Bureau of Labor Statistics to improve its calculation of the CPI (which it is already doing) or, if BLS won't move far or fast enough, want an ad hoc cut in each annual adjustment to save money for the Treasury. Inflation, however, is not the only source of rising nominal incomes and rising average and marginal tax rates under our graduated income tax. Real v , ii tax per capita income growth also rboosts nominal income. Even er time as per if inflation were zero, tax rates s rise. If the would rise over time as per tructUre is not capita real incomes rise. If the come changes, graduated tax rate structure is choke off not adjusted for real income her economic changes, it will eventually choke off incentives for economic growth. The growth in real incomes has many sources. These include, among others, wage hikes triggered by technological or productivity advances, increased education, and accumulation of income-earning assets on the part of savers. Whatever the source of the growth of incomes, the population faces higher tax rates unless the tax system is indexed to match the gains. Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to inorming the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www. ret.org

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