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New national data on poverty and income released this week by the U.S. Census Bureau reveals that from 2014 to 2015, median household income increased by 5.2 percent and poverty declined by 1.2 percent — good news by any measure. But these statistics don’t tell the full story.
Despite positive growth in incomes from 2014-2015, low-income earners were worse off in 2015 than they were 15 years ago because income growth has not been sufficient to keep up with inflation. Once the impact of rising prices is taken into account, incomes among the bottom 20 percent of earners in 2015 were actually 8 percent lower than they were in 2001, and incomes among the next 20 percent of earners were 4 percent lower than they were in 2001.
While low- and moderate-income taxpayers have less buying power today than they did 15 years ago, many are paying more in state taxes because too many state tax codes do not take the nuances of inflation into consideration. This phenomenon, dubbed ‘bracket creep,’ is the subject of a recent ITEP policy brief, “Indexing Income Taxes for Inflation: Why It Matters.”
State tax systems have many features that are defined as fixed dollar amounts, including the income levels at which various tax rates start to apply. If these fixed income levels aren’t adjusted periodically, taxes can go up substantially simply because of inflation. For example, in 1969 Illinois enacted a personal exemption of $1,000. If this amount had been adjusted for inflation since its enactment, taxpayers could exempt $6,550 per filer and dependent instead of the current $2,175.
Consider a hypothetical state that taxes the first $20,000 of income at 2 percent and all income above $20,000 at 4 percent. A person who earns $19,500 will only pay tax at the 2 percent tax rate (Figure 1). But over time, if this person’s salary grows at the rate of inflation, she will find herself paying at a higher rate—even though, in terms of the cost of living and ability to pay, her income hasn’t gone up at all. In this example, suppose the rate of inflation is 5 percent per year and the person gets salary raises that are exactly enough to keep up with inflation. After four years, that means a raise to $23,702. Whereas before all of this person’s income was taxed at the 2 percent rate, part of this person’s income ($3,702) will now be taxed at the higher 4 percent rate because the tax brackets haven’t also increased with inflation.
In this way, as the ITEP report Who Pays? notes, unfair state tax systems exacerbate widening income inequality. To learn more about “bracket creep” and the importance of indexing tax policy provisions, check out the brief!