by Paige Terryberry
Senior Analyst for Fiscal Policy, John Locke Foundation
In conversations about record inflation, most people harken back to the Jimmy Carter era where annual price inflation growth surpassed 10%. Inflation resulted in a boon to the government as “bracket creep” found taxpayers paying more on incremental income as their wages increased with inflation and propelled them into a higher tax bracket.
As a result, workers who found themselves no better off because their higher wages rose just to keep up with inflation were nevertheless confronted with a higher tax bill.
Since then, certain actions have been taken to soften the blow of the decreasing purchasing power of workers’ paychecks. In 1981 President Reagan enacted federal personal income tax indexing to protect workers’ wages. The bill adjusted tax brackets along with inflation, to ensure that taxpayers didn’t move up into higher tax brackets simply because their wages kept pace with the rising cost of living.
Some states have followed suit, indexing their tax brackets to inflation. Most states with graduated rate taxes (different rates for different incomes) have also adjusted these brackets for inflation. North Carolina has a flat income tax with sizeable standard deductions, not adjusted for inflation.
Experts at the Tax Foundation have advocated for adjusting the state standard deduction to inflation as a way to shield low-income families, in particular, from inflation. Some states already do this. At the federal level, the standard deduction is already indexed to inflation. If someone’s wages are tied to increasing inflation, they will not pay more federal taxes on the incremental income.
Today’s inflation has yet to reach the levels of the 70s and 80s. Thankfully, our tax code has evolved some to consider inflation’s effects on workers’ income. Indexing brackets, or the standard deduction in North Carolina’s case, would protect paychecks from this implicit and harmful tax.