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tax topics


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 2013 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. However, three individual income tax proposals would lack indexing—the increased refundability of the child tax credit, the expansion of the child and dependent care tax credit, and the estate and gift tax.. 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 and increasing the value of the credit for many families. The reverse would hold for the childcare credit: the threshold at which the credit rate would begin to phase down from 35 percent to 20 percent would remain fixed at $75,000 and the maximum amount of spending eligible for the credit would stay at $3,000 ($6,000 for more than one child). As a result, the value of the credit would decline in real terms over time.

Without indexing, the estate and gift tax would affect more estates over time as the value of the $3.5 million exemption falls in real terms. In addition, taxable estates would pay higher effective tax rates as a larger fraction of those estates would become subject to tax.