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1985 Federal Tax Policy Memo 1 (1985)

handle is hein.tera/fetxcyemo0009 and id is 1 raw text is: TAX FOUNDATION, INCORPORATED ONE THOMAS CIRCLE, N.W., SUITE 500 WASHINGTON, DC 20005 TELEPHONE (202) 822-9050 L_ FEDERAL TAX POLICY MEMO Editor: Edward A. Sprague, Vice President-Tax and Economic Affairs Some Second Thoughts on Indexing Some Tax Foundation members will recall our Federal Tax Policy Memo which was issued as a separate publication on a regular basis from 1978 to 1982 and sporadically since then. We have decided to revive this piece and extend its circulation by including it as an insert in most issues of Tax Features. As indicated by its title, Federal Tax Policy Memo will focus on current tax issues in an analytical and hopefully understandable manner. We will go light on the statistical tables although not promising never to use them. We hope to provide some useful observations on tax reform, tax burdens, budget policy and other such matters that the Congress and Treasury are, and will be, grappling with in our capital city. Reader suggestions and comments are most welcome and may be addressed to the Editor, Federal Tax Policy Memo. This year marks the start of indexing the Federal per- sonal income tax for inflation. The rate brackets and per- sonal exemptions are now adjusted to remove the effect of inflation as measured by the increase in the consumer price index (CPI) from October 1983-September 1984 over the previous 12-month period. That means a 4.1 percent factor applying to 1985 withholding tables as of January 1, 1985. As reported in the November-December 1984 Tax Fea- tures, indexing is expected to save individual taxpayers $8-10 billion in calendar 1985, with the largest percentage benefit going to middle-income taxpayers. The dragon of bracket creep has been slain! Presumably there is some rejoicing in the ranks. In the meantime, the Treasury Department has been busy putting together a plan for vast expansion of tax indexing throughout the economy for capital gains, inter- est, depredation and inventories. The revenue impact of such indexing would be very substantial even if inflation itself remains in the relatively modest 4-5 percent per year range. The revenue impact, of course, must be considered in the context of base-broadening measures in the reform plan designed to increase revenues and balance the overall program. Over on the budget expenditure side there are new efforts to restrain the cost of indexing entitlement pro- grams. The Administration/Senate budget proposal for fiscal 1986 for the first time would set across-the-board limits on automatic benefit increases under Social Security and Federal entitlement programs--in effect, reducing the inflation adjustment by two percentage points. The cumulative impact of this for fiscal 1986-88 would be bud- get savings of approximately $28 billion (with the inflation trend projection of about 4 percent a year under the Ad- ministration's original budget assumptions). Already, of course, there are instant warnings of hundreds of thou- sands of elderly being thrown back under the poverty line and other political rumblings that could derail such a bold move. But the logic of restraint here is compelling-both in terms of the deficit problem and sound long-term policy. Eventually, it should prevail. Indexing for entitlement benefits and indexing for taxes have distinctly different rationales. The former is a deliber- ate attempt to shield a segment of the population-mainly retirees-from the effects of inflation. The latter aims to correct for the unintended impact of inflation interacting with the progressive rate structure of the income tax and historic measurement of income. More broadly, tax index- ing aims to eliminate the unlegislated tax increase that has occurred because of the interaction of inflation and the tax structure, thus forcing Congress to make more explicit policy decisions with regard to both taxes and expendi- tures. Supporters of indexing refer to it as an honesty in budgeting tool. But, particularly if inflation adjustment limits are set for entitlements to bring them under better budget control, new questions are going to be asked about the extent of tax indexing, too. CPI Minus Two There was proposed legislation in the 98th Congress to limit the Social Security and Federal retirement cost- of-living adjustments (COLAs) to inflation rates above the first two or three percentage points of the CPI. There have been repeated proposals to delay COLA adjustments for six months or even a year. The mechan- ics of the present proposal give a little better break to beneficiaries by guaranteeing a two percent inflation adjustment and allowing almost full adjustment if infla- tion reignites to double digits but continuing the re- straint program over a more sustained period. This would result in quite significant future budget savings regardless of the specific rate of inflation (assuming it will stay above three percent). The projected COLA savings in fact are the single largest item in the Admin- istration/Senate deficit reduction plan next to reduction in defense from the earlier budget base line. Material in Federal Tax Policy Memo inaiy be reproduced freeh/. Credit to Tax Foundation, Incorporated, would be appreciated. :MAY 1985

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