Every year the IRS adjusts more than forty tax provisions for inflation. This is done to prevent what is called “bracket creep.” This is the phenomenon by which people are pushed into higher income tax brackets or have reduced value from credits or deductions due to inflation instead of any increase in real income.
The IRS uses the Consumer Price Index (CPI) to calculate the past year’s inflation and adjusts income thresholds, deduction amounts, and credit values accordingly.
In 2014, the top marginal income tax rate of 39.6 percent will hit taxpayers with an adjusted gross income of $406,751 and higher for single filers and $457,601 and higher for married filers.
The standard deduction, which all taxpayers can claim if they want it, increased by $100 from $6,100 to $6,200 for singles. For married couples filing jointly, it increased by $200 from $12,200 to $12,400. The personal exemption amount, which is available for all persons living in a household including the filer, increased by $50 to $3,950.
What does Hawaii do? For some reason, in 1978 when Hawaii adopted its present system of conforming to the federal Internal Revenue Code, inflation adjustments were left off the table. At that time, it took a lot of work and money to change our hard-coded computer systems to accept different rates and different threshold amounts. Over a long period of time, people’s income rose, but our tax thresholds didn’t.
As a result, today a single person making an amount equal to the federal poverty level, assuming they took one personal exemption (presently $1,144) and the standard deduction (now $2,200), would be taxed at our fourth tax bracket with a rate of 6.4 percent. Our top income tax rate, not counting the “temporary” rate increases adopted in 2009 and scheduled to sunset next year, is 8.25 percent.
What does that mean? We’ve been bracket creeped!
Being bracket creeped means that we are taxing the poor deeper into poverty. Fixing the issue, however, is not so simple because if we simply fixed the rates to tax lower income dollars at a lower rate, those rates would affect almost the entire population of our state and would result in massive revenue loss if we don’t do it right.
If we are going to do this right, we need to re-engineer our brackets to give relief to the people who need it, to be revenue neutral or close to it for those in the middle, and maybe ask a little more of the people now exposed to the 9 percent, 10 percent, and 11 percent rates.
That would bring back the “progressivity,” the principle of imposing the tax based on the ability to pay that has been slowly, but surely, vanishing from our income tax system as a result of bracket creep.
As to the 9 percent, 10 percent, and 11 percent rates, we need to remember that we taxpayers were promised back in 2009, that these rates would be temporary.
The mindless thing to do would be to leave the existing brackets in place and make the higher rates permanent – and I’m sure there will be bills introduced in the 2015 legislative session to do just that.
Lawmakers can and should be smarter about this issue, and hopefully they can deal with poverty relief at the same time they consider appropriate levels for the personal exemption, standard deduction, and the state’s tax bracket structure.
Because if they don’t, we can just call them bracket creeps.
• Tom Yamachika is interim president of the Tax Foundation of Hawaii.