As U.S. economy revs, all eyes on the Fed and on 10% tax cut which begins today
Today is tax-cut day. Federal income taxes drop 10 percent - and most taxpayers will find this more of a real gain than economists would have guessed a year ago when Congress approved the cuts.Skip to next paragraph
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It was widely expected last summer that ''bracket creep'' and the increase in social security taxes would cancel out any real improvement in incomes for most individuals.
Inflation has declined to a far lower rate than predicted, however. Thus bracket creep has not hit take-home pay so hard.
Also beginning this month, social security recipients start getting a 7.4 percent cost-of-living increase.
The combined tax cut and social security increase should put an additional $ 21.5 billion in consumers' pockets between now and the end of the year, the administration expects. It is hoped the extra money will give some boost to the economy.
Bracket creep results from the tendency of inflation to result in higher pay increases. Taxpayers move into higher tax brackets without necessarily any real gain in income. Federal revenues rise about 15 percent for every 10 percent increase in nominal incomes. The government therefore benefits from bracket creep. Because of reduced bracket creep, Paul B. Manchester, a staff economist with the Joint Economic Committee, says the 10 percent tax cut ''is turning out to be more of a real tax cut than was thought.''
Early in 1981, when Congress started to consider the tax cuts, economists were forecasting inflation running around 10 percent this year. The Congressional Budget Office, for instance, figured it would be 9.5 percent; Data Resources Inc., 10.2 percent; Chase Econometric Associates Inc., 9.9 percent; and Wharton Econometric Forecasting Associates Inc., 10.6 percent. By February of this year, the CBO inflation forecast was down to 7.5 percent for 1982; and by May, Data Resources had dropped its forecast to 5.8 percent, Chase to 5.7 percent, and Wharton to 5.5 percent.
In fact, inflation has been running about 3 percent for the last six months or so. But economists generally expect it to pick up somewhat in the next several months.
Another gain for taxpayers from lower inflation is that social security taxes will rise by a smaller amount next Jan. 1. Starting then, the wage base for social security taxes will be indexed to inflation during the prior fiscal year ending Sept. 30. At present, the 6.7 percent social security tax applies only to the first $32,400 of income.
Whether an individual benefits from the balance between an increase in social security taxes this year and the income tax cut depends largely on whether his or her income is close to that $32,400 base level. Those well above or well below that level will come out ahead, government experts say. Those close to it could suffer.
A person with a $24,000 salary gets a $289 reduction in income taxes, but because of extra social security taxes and bracket creep, could pay $135 more in taxes altogether.
In any case, the tax break won't mean a huge jump in take-home pay. The Internal Revenue Service has published new withholding tables for employers which indicate that the $175-a-week earner will get an extra dollar in take-home pay; the $250-a-week person, only 81 cents; and the $310-a-week individual, $1. 64. The person making more than $961 a week ($50,000 a year or more) with four personal exemptions will get an extra $13.41 in take-home pay.
Rosemary Marcuss, top tax analyst with the Congressional Budget Office, figures that most taxpayers will come out ahead in the social-security, bracket-creep, tax-cut wash.
Treasury calculations show that in fiscal '83, the total personal income tax cut (including the 10 percent next July 1) will amount to $74.1 billion. But assuming 7 percent inflation, bracket creep will shove up tax revenues $40.3 billion and social security taxes will rise $9.4 billion, leaving a genuine tax reduction of $24.4 billion. A similar calculation for fiscal '84, assuming 6.5 percent inflation, put the taxpayers ahead $34.6 billion.
The decline in bracket creep, however, may tempt Congress to trim or postpone the further 10 percent tax cut scheduled for July 1, 1983, in order to reduce the budget deficit. At least that is what the Joint Economic Committee's Mr. Manchester hopes. Writing in Tax Notes, a weekly tax service published by Tax Analysts, Arlington, Va., Manchester notes that the CBO calculated in March 1981 that bracket creep would raise taxes by $350 billion in the fiscal years 1982-86 , barring tax cuts. By February 1982, because of lower inflation, it had reduced this estimate to $254 billion, some $96 billion less. Manchester himself, assuming even less inflation in the years ahead, figures bracket creep will amount to only $196 billion. So, he argues, the 1983 tax cut could be postponed, cut to 5 percent, or eliminated and taxpayers would not be hurt so much as they would be if inflation and bracket creep remained as high as expected.