Spiraling inflation could mean higher taxes for millions of Americans – a phenomenon known as "bracket creep" that pushes taxpayers into higher-income brackets even though their purchasing power is unchanged due to wild surges in consumer prices.
A new analysis published Tuesday by the Tax Foundation shows that 15 states fail to account for inflation when drawing the brackets for taxes on wage and income, while another 18 states do not index personal exemption tax to inflation. Altogether, 22 states have at least "one major unindexed provision," which could mean higher taxes for individuals amid a recent inflation surge.
"When tax brackets, the standard deduction, or personal exemptions are not inflation-adjusted, they lose value due to inflation, raising tax burdens in real terms," said the analysis, authored by Tax Foundation's vice president of state projects, Jared Walczak. "Bracket creep occurs when more of a person’s income is in higher tax brackets because of inflation rather than higher real earnings."
The so-called "hidden tax" is most likely to affect residents living in states where taxes are not indexed to inflation, meaning there's no automatic cost-of-living adjustment built into the tax provision in order to keep pace with inflation. States with an income tax that is not indexed to inflation include Alabama, Connecticut, Delaware, Georgia, Hawaii, Kansas, Louisiana, Maryland, Mississippi, New Jersey, New Mexico, New York and Oklahoma.
For instance, a hypothetical Delaware resident who earned $60,000 in taxable income in 2019 and now makes $64,000 has not actually seen an increase in real income; the $64,000 she earns today has about the same purchasing power as the $60,000 she made in 2019, Walczak wrote.
On top of that, because her state's income tax brackets are not indexed to inflation, that higher salary pushes her into a higher property tax rate (6.6%), whereas before she was paying a rate of 5.5%. Though the resident's purchasing power is unchanged, her tax bill rises by $264.
"The absence or insufficiency of cost-of-living adjustments in many state tax codes is always an issue, as it constitutes an unlegislated tax increase every year, cutting into wage growth and reducing return on investment," Walczak wrote. "During a period of higher inflation, however, the impact is particularly significant."
The analysis comes days after the Labor Department released a report showing that inflation rose 5.4% in September from where it was a year ago, matching the largest increase since 2008. Consumer prices, meanwhile, jumped 0.4% in September from August.
The inflation spike appears poised to continue well into 2022: Economic projections from the Federal Reserve's two-day meeting in September show that headline inflation expectations for this year are 3.7% – almost a full point higher than the May forecast, when Fed officials projected it would hit 3%.