We’ve all heard the saying that inflation is a hidden tax. Depending on which state you live in, it should simply be called a tax – because that’s what it is. If you live in a state that fails to adjust its tax brackets because of inflation, then you end up paying more in taxes. It’s appropriately called “Bracket Creep.” Simply defined: Bracket Creep occurs when more of your income is in a higher tax bracket because of inflation rather than higher real earnings.
What is Your State’s Tax Rate?
Did you know that there are nine states that don’t have an income tax? They are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
That leaves 41 states (and the District of Columbia) that tax wage income. Of these:
- 15 states and D.C. fail to adjust brackets for inflation;
- 10 states leave their standard deduction (if they have one at all) unadjusted; and
- 18 have an unindexed personal exemption.
Combined, almost half of our states (22 + the District of Columbia) have at least one unindexed provision.
A Real Tax Increase
Let’s say you are a resident in one of those 22 states who made $60,000 in taxable income in 2019, but you saw your income increase to $64,000 the next year. While it’s great that you saw a raise last year, you really haven’t seen an increase in your purchasing power due to inflation. But it gets worse.
If your state’s income tax brackets are not inflation-indexed, since your top marginal rate was previously 5.55% (on income between $25,000 and $60,000), you now have $4,000 taxed at the higher rate of 6.6%. Your tax bill goes up by $264 even though your purchasing power remained the same.
Saying inflation is a hidden tax is simply not true. It’s a very real tax that you have to pay with very real dollars.
Tax Planning is Important
For most people, tax strategies can be overwhelming, especially given that the federal and state tax codes are thousands upon thousands of pages long. Throw in the emotional toll of figuring out what Congress and state legislatures are going to do next and it’s no wonder tax worries can be paralyzing, pushing you to do nothing. Before you go down a path that might not be in your best interest long–term, an advisor can model out different scenarios with different tax assumptions so you can see how a few tweaks – or a few more significant changes – might help you keep more of your hard-earned money.
