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Sound Money Blog

Too Late, Fiscal Cliff. Bracket Creep Beat You To It.

Posted by Gonzalo Schwarz
December 17, 2012

by Devin Roundtree

In order to avert next year’s automatic spending cuts, President Obama has called for a return to President Clinton’s higher tax rates on incomes over $200,000 ($250,000 for joint filers). But the President’s proposal will actually increase rates well beyond his democratic predecessor. Back in the 1970s when inflation ran wild, many workers were forced into higher tax brackets even though their incomes did not rise in real terms. This phenomenon, known as bracket creep, became a major platform for the supply side revolutionists that convinced lawmakers to increase the dollar range of tax brackets to account for the increase in the cost of living. For a while this worked. But the disconnect between the Consumer Price Index and reality has widened, and tax payers are again feeling a pinch that will hurt more if President Obama’s plan passes.

$200,000 just isn’t what it used it to be. Today if you make this much, you are considerably rich given your top 5% status.  Yet in the early 1970s, the typical middle class household earning $10,500 had the same purchasing power as $200,000 today and paid a top tax rate of 27%. But unlike their disco dancing middleclass counterparts, today’s earners of $200,000 are subject to a 33% tax rate. If President Obama really returned to the tax rates of Clinton, those making over $200,000 would actually get a tax cut.

Back in 2000, $67,600 had as much purchasing power as $200,000 today, putting the top tax bracket at 31%. After the Bush tax cuts, the top tax rate on the value of $200,000 today dropped back to 28% where it was for most of Clinton’s presidency. Unfortunately, the manipulation of the CPI has led the IRS to undervalue past income levels and levy higher tax rates. According to the new CPI, $148,500 in 2000 had the same purchasing power as $200,000 today. So if the President gets his way, the top tax rate on the value of $200,000 today will rise to an all-time high of 36%.

The return of bracket creep partly explains why the upper class now pays a greater share of income taxes despite paying far lower tax rates. For instance, the percent of all income taxes paid by the top 5% has risen from 37% in 1980 (when the top tax rate was 70%) to 57% today. The upper class is already paying the majority of income taxes, but somehow they aren’t paying their “fair share.”

This is not to suggest that the U.S. should avoid the fiscal cliff. The paltry reduction in government spending is a step in the right direction and there are worse ways to deal with too much spending than raising taxes. If the government continues to inflate the money supply to help finance spending, the inflation tax will rise uncontrollably. And unlike the income tax, the inflation tax is in no sense “progressive.”

Devin Roundtree received his M.A. in economics from the University of Detroit Mercy.

image: stockmonkeys.com