The tax law that became effective Jan. 1 makes many changes to federal personal and corporate taxes including one that has received little attention but could have a major and widespread impact long term. It has to do with how tax provisions are indexed for inflation.
Under the new legislation marginal personal tax rates, tax credits and the standard deduction, which was doubled are indexed to inflation using the Chained Consumer Price Index for All Urban Consumers, or C-CPI-U, instead of the more traditional CPI-U.
The chained CPI, like traditional CPI measures, tracks the prices of a basket of goods and services but adjusts for changes in purchases as consumers substitute cheaper products and services for more expensive ones. As a result, the chained CPI usually rises more slowly than the traditional CPI measure.
Linking tax brackets to the chained CPI means taxpayers will move more quickly into higher brackets as their incomes rise, but the tax credits they receive and standard deduction they take will rise more slowly. And many more taxpayers are expected to take the standard deduction due to the elimination of many itemized deductions and limits on others such as the state and local tax deduction.
Tax experts David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, and Howard Gleckman, a senior fellow at the Tax Policy Center, say the inclusion of the chained CPI as an inflation index in the new tax legislation is the first federal government use of the index that they know of. Both expect its usage will likely grow over time.
“Someday, Congress will move to restrain spending on federal retirement and health programs,” says Wessel. “When that happens, using the chained CPI to adjust benefits for inflation surely will be an option high on the list; using it for tax brackets makes that a bit more likely.”
Mary Johnson, Social Security and Medicare policy analyst at The Senior Citizens League, is concerned that the chained CPI could become the index used to set the Social Security cost of living adjustment (COLA), which is currently linked to the CPI-W, for Urban Wage Earners and Clerical Workers, a subset of the CPI-U that tracks retail prices as they affect urban hourly wage earners and clerical workers.