Measurement Tool Used In New Tax Bill Will Impact Deductions And Brackets

The government tracks prices on consumer goods — eggs, shoes, gasoline, etc. But when prices rise, people often make substitutions, like buying chicken if beef gets expensive. So economists have come up with the notion of "chained inflation" to take substitutions into account. That's the measurement the new tax bill uses, and it makes the consumer price index smaller, with an impact on deductions and brackets.

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The tax bill that President Trump signed into law last week will usher in lots of changes. One we haven't heard much about yet is likely to raise the amount of money most people pay in taxes over time. It has to do with the way inflation is calculated. NPR's Jim Zarroli explains.

JIM ZARROLI, BYLINE: To understand the change, you have to go back to the 1970s. Back then, tax brackets were fixed, so if your salary rose to a certain level, you had to pay taxes at a higher rate. But rampant inflation was eating into people's purchasing power. Douglas Holtz-Eakin is former director of the Congressional Budget Office.

DOUGLAS HOLTZ-EAKIN: People were being pushed into higher tax brackets just due to inflation alone. They actually weren't more affluent, and that seemed inappropriate.

ZARROLI: So in the 1980s, Congress made an important change. Tax brackets were for the first time tied to the inflation rate, and the inflation rate was measured using the government's Consumer Price Index, or CPI. The Labor Department calculates the CPI by looking at a basket of goods - things like a gallon of gasoline, a pair of shoes, a pound of chicken - and then keeping track of how much prices for those items change. But a lot of economists don't like the CPI. They say in the real world, when prices go up, people tend to do a lot of substituting. Holtz-Eakin says they look for cheaper alternatives.

HOLTZ-EAKIN: Unfortunately when prices for goods go up, people tend to purchase less of them. So the baskets change from year to year.

ZARROLI: So economists came up with the concept of chained CPI, which attempts to account for the way these real-world purchasing decisions are linked. And the new tax law uses this chained CPI to determine tax rates. Chained CPI tends to rise more slowly than the traditional measure of inflation, so using it will change the rate at which tax brackets get adjusted. The effect will be that when people's salaries go up, they will get pushed into higher brackets sooner. Steve Rosenthal of the Tax Policy Center says the difference in tax rates won't be very big.

STEVE ROSENTHAL: But over time, these fractions of a percentage point add up and can amount to a fair amount of money.

ZARROLI: Rosenthal notes that the new law will cut many individual's taxes, but the cuts expire after a few years while chained CPI is forever.

ROSENTHAL: And so compared to where taxpayers would be under present law, by 2027, most individuals will actually pay more taxes.

ZARROLI: To David Kamin, former economic adviser to President Obama, this move toward chained CPI may make economic sense, but it needs to be looked at in context.

DAVID KAMIN: It's one thing to put in chained CPI if you think that it's going to go to, you know, actually helping working families. It's another thing if you're doing the chained CPI to pay for a permanent corporate rate reduction.

ZARROLI: And Kamin says the precedent being set here is important because some lawmakers want to see chained CPI used more broadly by the government to determine things like Social Security increases and Medicare payments. Jim Zarroli, NPR News, New York.

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