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Bracket creep in the age of indexing: have we solved the problem?

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Abstract

An examination of the inflation-indexing provisions contained in the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986.
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... The variable P f,t is the policy maker's choice of index. As noted by Altig and Carlstrom (1991), the US federal income tax code is indexed to lagged inflation, which would imply the use of P f,t ≡ P t−1 under this specification. 9 This could be replaced by the current price level, making it perfectly indexed, or even lagged expectations of the current price level E t−1 (P t ), for example. ...
... As is noted by Altig and Carlstrom (1991), the Federal Income Tax in the United States is not perfectly indexed. Rather, the index used is lagged by 16 months. ...
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This paper considers the consequences of automatically indexing the US federal income tax code to inflation. Indexation, implemented during the 1981 federal tax overhaul, and active monetary policy constitute necessary conditions for a unique rational expectations equilibrium in standard New Keynesian models with a generalized, progressive labor income tax. Additionally, fixing the monetary regime shows that indexation reduces overall volatility in the model as well as the contribution of supply-side disturbances. Together, these results support a fiscal extension to the “good policy” hypothesis of the Great Moderation and encourage further indexation of the United States tax code.
... The bracket creep -the situation, repeatedly, where inflation pushes income into higher tax brackets, although the real income remains unchanged, and consequently this fictitious extra income causes the increases in real tax burden for taxpayers -is not a new tax policy issue (see also von Furstenberg, 1975;Sunley and Pechman, 1976;Bailey, 1976;Jarvis, 1977;Altig and Carlstrom, 1991;Immervoll, 2005). In particular taxpayers near the top-end of a tax bracket are more likely to creep to a higher bracket and thus experience a rapid rise in marginal rates (Saez, 2003). ...
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A reexamination of the potential costs of anticipated inflation in view of the inflation indexing system established during the 1980s.
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Because wealth estimates from survey data have usually fallen substantially short of independent aggregate estimates, survey data have not been seen as adequate for assessing questions dependent on a good representation of the entire distribution of wealth, such as estimates of wealth concentration. The 1983 Survey of Consumer Finances (SCF), which contains a supplementary sample of very high income households drawn from a tax-file sample frame, is the first U.S. survey since the 1963 Survey of Financial Characteristics of Consumers that offers hope of accurately measuring the entire wealth distribution. In this paper, we discuss the design of the survey, the critical issue of proper weighting to merge the supplementary sample with an area probability sample, and the role of imputation. We show that the use of ordinary area probability samples alone leads to probable bias in the measurement of highly concentrated assets such as stocks and bonds. We compare the SCF data with aggregates derived from the flow-of-funds accounts of the Federal Reserve Board. While methodological issues cloud exact comparisons, it appears overall that the SCF estimates are at least as credible as other aggregate measurements. Finally, we use the data to assess the change in concentration of wealth from 1963 to 1983. We estimate that the concentration of wealth in terms of households did not change significantly over this period.
Towards an Understanding of the Costs and Consequences of Inflation,@@ reprinted in S. exina. Inflation. and Economic Policv Fischer
  • S Fischer
  • F Modigliani
Fischer, S. and F. Modigliani, "Towards an Understanding of the Costs and Consequences of Inflation,@@ reprinted in S. exina. Inflation. and Economic Policv Fischer, Ind , MIT Press, Cambridge, Mass., 1978.
nFederal Income Tax Reform in 1985: Indexationfn Review, Federal Reserve Bank of St
  • J Tatom
Tatom, J., nFederal Income Tax Reform in 1985: Indexationfn Review, Federal Reserve Bank of St. Louis February 1985.