Inflation is boosting government revenue at your expense.
The Congressional Budget Office has released its latest budget and economic outlook, revealing that individual income tax collections for the fiscal year ending September 30, measured as a percentage of gross domestic product, are projected to be the highest in the history of the U.S income tax, which dates back to 1913.
Total federal tax revenue is projected to reach 19.6% of gross domestic product for only the fourth time in history. It happened in 2000, during the dot-com bubble, and twice during the Second World War.
One reason for this federal tax windfall is inflation, which drives up asset prices and wages. That translates to higher taxes from capital gains due to the sale of assets, and higher tax rates for ordinary working people who are actually falling behind financially despite higher wages.
The CBO report explains the effect of what it calls “real bracket creep.” Between 2023 and 2032, the CBO projects that more income will be pushed into higher tax brackets. The Internal Revenue Service adjusts the bracket thresholds before the start of the tax year, which means the current year’s inflation leads to a larger share of income being taxed at higher rates.
“Real bracket creep” and other lagging or missing inflation adjustments will cause projected annual revenues as a percentage of GDP to increase by 0.3 percentage points from 2023 to 2032, the CBO calculates.
The same bracket creep affects state income taxes. California, with the highest state income tax in the nation, is seeing record revenue pouring into the treasury. Taxpayers who find themselves pushed into a higher tax bracket by cost-of-living raises will not be celebrating the state’s record surplus.
Higher wages that result from inflation also come with a bigger bite in payroll taxes.
Along with the higher taxes, inflation brings reduced purchasing power for consumers. For the government, however, higher prices bring higher sales tax revenues. California has the highest state sales tax in the nation at 7.25%.
The state’s Legislative Analyst’s Office is forecasting a 20% increase in revenues in 2021-22 from the state’s three largest taxes, the personal income tax, the sales tax and the corporation tax. Inflation, the LAO wrote, “has contributed to the rapid growth in revenues in 2021-22.”
Of course, it’s not all good news for governments. The LAO explains that “persistently high inflation also would increase the state’s costs to meet its existing obligations.”
That might lead California lawmakers to seek more tax increases from beleaguered California residents already struggling to make ends meet.
Early in the Biden administration, former Treasury Secretary Lawrence Summers warned that excessively large federal spending bills for emergency relief and infrastructure risked triggering inflation that the Fed would not be able to control short of inducing a painful recession. When inflation began to rise, officials in the Federal Reserve and in the administration said it would be “transitory” and was due to temporary conditions resulting from the pandemic.
Nobody’s saying that now.
With the U.S. inflation rate at its highest point in 40 years, President Joe Biden is seeing his approval rating scrape new lows. Gallup found that only 16% of Americans say they are “satisfied with how things are going in the country,” with 83% dissatisfied.
It may be that inflation is only good for government until the polls open.
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