Indexing the Budget Tax Proposals

Much of the federal income tax is indexed for inflation to prevent nominal income growth from pushing taxpayers into higher tax brackets and the consequent higher effective tax rates, a phenomenon known as “bracket creep.” Most but not all of the tax proposals in the 2010 budget include indexing provisions and as a result, they will maintain their value over time in real terms.

Some proposals would maintain their real values because they interact with tax parameters that are indexed.  Other proposals would fix important parameters in dollar terms and thus lose or gain value over time.  Those proposals include:

• Making Work Pay credit: The maximum dollar value of the credit would stay at $400 ($800 for married couples filing jointly). By 2017, that value would drop to $358 in real terms, a drop of 9 percent. The phaseout range would be indexed, however, so it would maintain its real value over time.
• Increase refundability of the child credit: The earnings level at which refundability of the child credit would start to phase in for low-income families would be fixed permanently at $3,000. Over time, that value would decline in real terms, effectively extending the refundability of the credit to lower income households. By 2017, the threshold would drop to $2,688 in 2009 dollars.

The lack of complete indexation means that the real effect of the president’s tax proposals would change over time. In 2017, 85 percent of all taxpayers would get tax cuts—relative to current law—down from 87 percent in 2012. Measured against the administration’s preferred baseline, the percentage of taxpayers who would see their taxes go down would fall from 76 percent in 2012 to 72 percent in 2017.