Policy makers in a handful of states are seeing an opportune moment to adjust their personal income tax brackets to inflation as the financial stress of housing costs and high grocery bills continues.

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States See Chance to Fix Tax ‘Bracket Creep’ as Inflation Persists

Policy makers in a handful of states are seeing an opportune moment to adjust their personal income tax brackets to inflation as the financial stress of housing costs and high grocery bills continues.

Lawmakers in New Jersey and Connecticut have gotten lukewarm receptions from their executive leaders, while governors in Hawaii and Puerto Rico have been more eager to embrace—and are themselves pitching—these tax changes to help residents absorb significant increases in the cost of living.

If any are successful, they would join the large majority of states. Currently, just 14 states don’t index their income tax brackets for inflation—including Connecticut, Georgia, New York, New Jersey, and Virginia—causing millions of Americans to finance a hidden tax in their paychecks.

When states don’t index for inflation, real effective tax rates rise over time. “Bracket creep,” as it’s known, means that many US taxpayers may pay more in personal income tax every year, even when inflation is low.

“If states don’t already inflation-adjust their income tax codes, they should now,” said Jared Walczak, vice president of state tax projects at the Tax Foundation. “It’s an appropriate response to rising inflation to ensure that inflation doesn’t take taxpayers while they’re down, not only reducing the value of their earnings, but increasing their effective tax rate.”

Stubbornly High Prices

Consumer prices remain high, clocking in at a 6.4% increase from a year earlier, according to the latest Bureau of Labor Statistics report. Housing and energy costs account for some of the biggest jumps, putting pressure on the Federal Reserve to raise rates even higher to cool prices.

The Internal Revenue Service regularly adjusts federal income tax brackets, but states act at their own discretion. Of the states that tax personal incomes, some—including Rhode Island, Wisconsin, and Montana—index the income brackets, while others, like Maryland, only index the standard deduction. Georgia and Oklahoma are among those not providing any inflation accommodation at all.

Governors in both parties, across the country, have prioritized affordability in many of their budget proposals this year as taxpayers face increased living expenses. To help, they’ve offered other relief options, such as income tax cuts and property tax rebate checks.

“We have been seeing states cutting taxes because of the strong revenue and rainy-day fund budgets,” said Lucy Dadayan, a senior research associate with the Urban-Brookings Tax Policy Center, but “adjusting the brackets is a much better policy.”

Cost-of-Living Reality

Puerto Rico’s Gov. Pedro Pierluisi pitched a cost-of-living adjustment (HB 1576) in January that would link three tax elements to inflation: income brackets, the standard deduction, and the personal exemption. It also would calculate the adjustments every year afterward based on a formula—the percentage change when comparing the current consumer price index with the previous year’s index.

Pierluisi’s plan aims to be in place quickly, taking effect for the 2023 tax year. Taxpayers would see a 2.4% rate adjustment in their favor in 2023 and it could be much higher in 2024 given rising prices, the governor said in a news conference in January.

“The cost-of-living adjustment, which is already being used at the federal level to offset increases in goods and services, will help the citizens of Puerto Rico to recover, in some way, part of the price increases that they have experienced in almost all categories during the past years,” said Puerto Rico Treasury Secretary Francisco Parés Alicea.

Newly elected Hawaii Gov. Josh Green (D) supports a measure (HB954 HD2) that would create inflation-indexed taxes by employing a “cost of living adjustment factor” beginning in tax year 2023. The factor would be determined by calculating the percentage change in the consumer price index.

“The governor wanted to compensate and help alleviate the burdens of inflation to the people of Hawaii, and that’s why he’s suggesting this change, to avoid bracket creep,” said Seth Colby, tax research and planning officer at the Hawaii Department of Taxation.

Cost-Benefit Politics

Lawmakers in Connecticut and New Jersey have offered other legislative fixes to address the inflation squeeze on their residents. While these changes would entail states forgoing future revenue, officials argue it’s worth it given the states’ significant surpluses.

The absence of an adjustment is an “oversight in our system,” said Rep. Josh Elliott (D), sponsor of a Connecticut bill to index income brackets to inflation (HB 5668). “This is not the place that governments should be seeking revenue in the first place.”

Jeffrey Beckham, secretary of Connecticut’s Office of Policy and Management, who testified in February on Gov. Ned Lamont’s $50.5 billion biennial budget proposal, threw cold water on Elliott’s bill, saying “The short answer is that would produce a loss.” A representative for the governor’s office didn’t respond to a request for comment.

Instead, the Democratic governor has pledged the state’s first tax rate cuts in almost 30 years for families making up to $100,000 a year. “I want a sustainable tax cut that we can support in good times and not-so-good times,” Lamont said in a budget address. “We’ve had a number of false starts, on again, off again tax cuts—not this time.”

New Jersey Gov. Phil Murphy (D) touts the 18 tax cuts he has delivered during his tenure as well as a $2 billion property tax rebate for residents, but some Republicans say more is possible.

For years, Sen. Anthony Bucco (R) has pressed Murphy to index the state’s tax brackets (S 676) to inflation despite an estimated loss of $500 million in revenue. Bucco argues that the time to act is now, especially given the state’s multibillion-dollar surplus as part of the governor’s proposed $53 billion fiscal 2024 budget.

“We’re sitting on a $10 billion surplus,” Bucco said in an interview. “That’s just a small percentage of that surplus that could be used to help our taxpayers. Not to make this small change when 37 other states do is crazy.”

Mahen Gunaratna, a spokesman for Murphy, declined to comment on pending legislation.

Non-Tax Options

While New York officials haven’t proposed a plan to adjust personal income tax brackets to inflation, Amanda Hiller, acting tax commissioner and general counsel of the finance department, acknowledged the arguments in favor of indexing, but said there could be a number of other ways to tackle it.

“We could consider changing the current income tax rate structure to address that kind of creep, and it might include indexing,” Hiller said in response to a question from a Republican senator at a joint budget hearing in February. “But it might include other ways of adjusting the brackets.”

New York Gov. Kathy Hochul (D) is proposing as part of her $227 billion fiscal 2024 budget automatic increases to the state’s $15-an-hour minimum wage to help lower-income residents keep pace with inflation.

The monthly cost of goods and services for households has risen by 13.4% since October 2020, while the purchasing power of the $15 minimum wage has lost $1.78, making it tougher for low-income families to shop for groceries and fill up at the pump, according to the governor.

“Indexing our minimum wage to inflation will ensure that purchasing power of workers’ wages aren’t eroded year over year,” Hochul said in her January address.

While states like New York are exploring other ways of responding to rising costs, tax policy experts argue inflation indexing is the right next step to help taxpayers, even if it means less revenue.

“It’s a good thing to do for taxpayers, not necessarily for the government, because that means that they will get less money,” said Dadayan. “The inflation adjustment would help to ease the tax burden that was caused by the high inflation.”

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