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Trump Tax Cut to Be Eroded Next Year by Inflation Switch
IRS announces details of change in calculations required by tax law, meaning brackets and deductions now grow more slowly
In technical terms, the IRS is switching from using the traditional measure of inflation—called CPI-U—to a version known as chained CPI, or consumer-price index. PHOTO: SUSAN WALSH/ASSOCIATED PRESS
WASHINGTON—Last year’s big tax cut is about to start shrinking.
The Internal Revenue Service on Thursday announced the tax code’s parameters for 2019, implementing a new method for making inflation adjustments that will result in higher tax payments—and government revenue—over time.
The shift will cost Americans $133.5 billion over a decade, according to Congress’s Joint Committee on Taxation.
The tax law enacted last year lowered tax rates and reduced tax burdens for most households in 2018. It also required the IRS to switch to a different, slower-moving measure of inflation to adjust a variety of tax-code features for rising prices.
The standard deduction, tax brackets and other items will still increase most years, but now they will usually climb more slowly than they would have under the old formula.
The result: More income gets taxed at all, or taxed at higher rates.
The bite starts as a nibble. In 2019, the standard deduction for a married couple will be $24,400. The deduction would have been $24,550 under the old inflation-adjustment method, according to calculations by the Tax Foundation, a conservative-leaning group.
In the 24% tax bracket, making the standard deduction $150 smaller than it otherwise would have been would cost a taxpayer $36 in higher taxes. That will be reflected on tax returns filed in early 2020.
The gaps widen over time. Many taxpayers got their largest benefit from the new tax law in 2018 and will watch it shrink annually.
“When you sit down and figure out your taxes, I don’t think you’re going to notice this amongst all the other noise,” said economist Jared Bernstein, a senior fellow at the left-leaning Center on Budget and Policy Priorities.
The start of the 37% top bracket for individuals, set at $500,000 for this year, will rise to $510,300 in 2019 under the new inflation-adjustment method. Under the old system it would have been $512,075, the Tax Foundation calculates. By 2025, the gap between the old and new top tax brackets is projected to be $10,325.
The bites add up over time. Nationally, the inflation change will raise $2.1 billion in additional federal tax revenue in fiscal 2019, growing each year to $20 billion in fiscal 2025 and continuing beyond that. Unlike many other tax-code changes, the new rules aren’t scheduled to expire.
By 2025, 8.9% of taxpayers will pay more than they would have under the previous tax law, according to the Tax Policy Center, a research group run by a former Obama administration official. In 2018, 4.8% of households pay more.
“It is a broad change to the definition of what is taxable and the change is very subtle,” said Kyle Pomerleau, director of the Center for Quantitative Analysis at the Tax Foundation. “It will take years before it really kicks in and tax bills are noticeably different. However, even then it will be hard to tell because everyone’s economic situation will have changed.”
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The IRS announcement came several weeks later than is typical. Usually, the tax agency lists the next year’s brackets in October.
In technical terms, the new tax law switched from using the traditional measure of inflation—called CPI-U—to a version known as chained CPI, or consumer-price index.
Many economists view chained CPI as more accurate because it better reflects consumers’ tendency to buy cheaper alternatives as prices increase. The measure typically rises more slowly than CPI-U. For 2019 tax purposes, inflation measured by the rise in chained CPI was 2.06%, compared with 2.42% for CPI-U, according to the Tax Foundation.
That change makes sense economically, said Mr. Bernstein, who was an adviser to Vice President Joe Biden. But Mr. Bernstein added that lawmakers should consider other changes to offset the impact on low-income households. Measured as a share of income, changing to chained CPI affects high-income households the least, according to a 2013 analysis by the Tax Policy Center.
During last year’s tax debate, Democrats opposed the move, worried that Republicans would next try to apply chained CPI to spending programs such as Social Security. That would slow the growth of benefits, a move long sought by advocates of reducing federal budget deficits.
President Obama proposed that idea in bipartisan budget talks that eventually collapsed.
Several tax-code features aren’t indexed for inflation. For example, Congress just doubled the child tax credit to $2,000 and set it to phase out at annual income above $200,000 for individuals and $400,000 for married couples.
Unless Congress acts, none of those numbers rise with inflation and the child credit’s value declines, contributing to the gradual fade of last year’s tax cuts.
Among other changes the IRS announced Thursday, the maximum earned-income tax credit for families with three or more qualifying children will increase to $6,557 from $6,431.
The dividing line between the 24% and 32% brackets will now be $160,725 for individuals and $321,450 for married couples, up from $157,500 and $315,000 this year. In 2018 those thresholds also denoted where the new tax deduction for pass-through business income begins phasing out for some businesses. But because of the way rounding in the tax code works, the two figures begin diverging in 2019. The pass-through threshold increases to $160,700 for individuals and $321,400 for married couples, slightly less than where the brackets change.
The per-person estate-tax exemption will rise to $11.4 million from $11.18 million; the annual gift-tax exclusion remains $15,000.
Write to Richard Rubin at richard.rubin@wsj.com
Appeared in the November 16, 2018, print edition as 'New Calculus on Inflation Erodes Tax Cut.'
