We always talk about Inflation and Personal Income tax but very few know about it. Here’s an example. If you are saving $500 every year, are you able to spend those $500 like you used to do one or two years before? The answer is No. You could buy anything you wanted for $500 before but today $500 would not be enough for you. Unfortunately, this is the time when the economy faces inflation. The problem with it, though, is that you inevitably pay an inflation tax without even realising it. Next year, the identical item you purchase will cost more, but it will also be less valuable. Now, Let’s talk about the personal income tax adjustment for inflation.
Strategies for Adjusting Inflation
Personal income tax adjusts for Inflation but how could it do better? We cannot do much only by adjusting the inflation. There are some other ways, measures, and strategies which can help to adjust it. There are some tax brackets. Tax brackets are some structural elements that have some tax code. Some inflation-related issues, particularly those involving capital gains, call for a more thorough analysis of the income tax system, ideally by switching to a consumption tax base where all income is taxed just once.
The standard deduction and personal income tax brackets are both registered for inflation. Some things are adjusted by inflation and some are not. The maximum Earned Income Tax Credit (EITC) amounts, the annual exclusion for gifts received, the income threshold for the alternative minimum tax, the restrictions on the twenty percent pass-through business income deduction, and the capital gains tax brackets are just a few examples of the tax provisions that have been updated to reflect inflation. The maximum value of the Child Tax Credit (CTC) does not adjust for inflation, although the refundable component is. Whether it makes sense to factor in inflation for many other individual income tax provisions depends on how one views the best way to set up the income tax system.
Neutral Income Tax
A saving-consumption-neutral income tax only taxes income when it is used up. A consumption-neutral income tax only levies taxes on income that is actually spent. Savings, in other words, are deductible when they are earned but are taxed when they are realised. It would be effective to use personal income tax to adjust inflation by creating universal savings accounts where all money would be eligible for classification and taxed at regular income rates.
Capital Gain or Loss
For the Federal Government, taxes on capital gains are more important and have the most moving graph and income. When something is purchased at one price and you want to sell it after some time there will be some other price after a particular time in the market. It could be any sort of property (real estate), gold, car, or anything. You can have a gain or loss at that point.
According to the tax law, capital gain taxes are not calculated annually based on gains over some time. But they are paid only once, in the year that an asset is sold. Increased incentives for saving and investing could be a result of indexing capital gains.
-
The fact that capital gains are not adjusted for inflation when taxed raises the effective tax rate on savings
The real return on saving and investing would grow with a reduced effective tax rate (accomplished by capital gains that are adjusted for inflation), which might also lead to higher levels of capital formation, higher wages, and more jobs. However, for these incentives to work, the change would need to be reasonably believed to be permanent, which may not be the case given the current state of mounting deficits.
-
Inflation and Difficulties with Capital Gain
Inflation-related difficulties with capital gains tax would be addressed more generally with the implementation of a saving-consumption-neutral income tax. Because gains are lost to inflation, taxpayers are currently required to pay capital gains taxes even if they aren’t making any money.
Verdict
Without the difficulties of indexing, the inflation issue could be solved by swapping out the existing personal income tax for a saving-consumption-neutral tax. Consider a system where all savings are subject to tax treatment, meaning that they are first deducted from earnings and only later subject to tax when they are used. In such a system, the taxpayer is solely responsible for paying taxes based on the change in real worth, not inflation. One suggested solution is to adjust the basis (the original investment’s value) for inflation so that the capital gains tax only applies to actual income growth.
Author Bio
Lucas Zac is a taxation expert. He provides sales tax audit services to his clients. The author is expert in small business accounting, personal tax resolutions, personal finance advice, billing, invoices and payroll. His way of elaborating is so clear that it can make understanding easier.
