Why Are Only Some Tax Breaks Adjusted for Inflation?

Unfortunately, whether a tax provision is inflation-adjusted is dependent on whether lawmakers believe there is enough money to allow for it when they are drafting legislation. More often than not, inflation accommodations are the first to go during negotiations in Congress — and then are easily forgotten. And so, we’re left with a US tax code that’s a total hodgepodge.

Sure, gasoline prices may be cooling, but annual inflation remains north of 8% and food prices are still elevated. When inflation is high, those adjustments matter even more because they increase the value of tax credits and deductions. Without them, tax benefits effectively stay flat as everything else becomes more expensive.

Another way things are skewed is when the income thresholds to qualify for certain tax credits and deductions, as well as those that trigger certain taxes (such as the net investment income tax), don't keep pace with inflation.

For example, the thresholds for owing the net investment income tax, which subjects those with higher incomes to a tax on investment income to help pay for Medicare, have been set since 2013 at $200,000 for single taxpayers and $250,000 for those married filing jointly. Adjusted for inflation, those cutoffs would now be $257,000 and $322,000, respectively, according to Alex Muresianu at the Tax Foundation.

Going back to the child tax credit, a helpful example from the Urban-Brookings Tax Policy Center shows how the lack of inflation adjustments can add up over time. If the current $2,000 credit stays the same, by 2032, it will be worth just $1,430, based on inflation projections from the Congressional Budget Office.

Remember, the child tax credit was increased as part of the 2017 tax overhaul to compensate for ending the personal exemption for dependents, which was the amount of money taxpayers used to be able to exclude from their income for having children. The personal exemption was inflation-adjusted, whereas the maximum amount of the child tax credit isn't.

The child tax credit was boosted again during the pandemic to help lower-income families, but that increase expired at the end of last year. So households that are suffering the most are receiving less and have no inflation adjustment to cushion the blow.

It's a similar story for deductions for interest paid on student loans. While the income limits to qualify for deducting the interest on student loans are adjusted annually for inflation, the maximum deduction — $2,500 — is not, and has been in place since the early 2000s. (Student loan repayments have been frozen since March 2020 due to the Covid-19 pandemic.)

The hot housing market has also raised questions about why the amount homeowners are allowed to exclude from their taxes when they sell a primary home has been stuck since 1997 at $250,000 for single taxpayers and $500,000 for those married filing jointly. A report by the Congressional Research Service points out that the average price on the sale of an existing home has increased by 151% since then, and suggested that lawmakers consider indexing those numbers to general inflation or housing prices.

There are some tax issues where the argument for automatically indexing to inflation is more complicated. Under the current system, capital gains aren't indexed, so when someone sells a stock or home for a profit, the original purchase price isn't adjusted for inflation. Such a wholesale change would result in a significant budget deficit and disproportionately benefit the wealthiest taxpayers.

But there are many other places in the tax code where an annual nod to inflation would be an easier lift. If lawmakers are looking to make higher prices easier to bear, one of the most practical ways to start would be with actual inflation adjustments.

Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

Read more articles by Alexis Leondis