On October 3, 2008 the California Franchise Tax Board (FTB) announced that the 2008 state tax brackets have been adjusted for inflation using a process called “indexing.” As it does every year, the announcement included the following quote ... the only variables in the quote being the percentage (5% this year; it was 3.1% last year) and the name of the State Controller:
“By indexing the tax rates, a California household with unchanged income will pay 5 percent less in State income taxes,” said State Controller and FTB Chair John Chiang.
I don't know if the FTB is too stupid to realize it, or believes everyone else is, but the above sentence simply isn't true for most California taxpayers. Depending on where one's income happens to fall within any of California's first five tax brackets ... 1%, 2%, 4%, 6%, 8% ... the actual reduction in tax on the same year-to-year taxable income ranges from 0% to 8%. And once a taxpayer's income reaches and extends into the state's highest tax bracket of 9.3%, which for a single person starts at $47,055, that touted 5% reduction goes steadily down and almost reaches zero. A single person's 2008 California tax on income of $60k is only 3.2% less than the tax on the same income in 2007; on income of $100k it's only 1.5% less; and on income of $250k it's only 0.5% less.
The so-called federal indexing works the same way and produces equally misleading results. This is because the TAX isn't really indexed at all ... only the START of the various tax brackets is inched up by the prior year's rate of inflation, or COLA, or whatever benchmark is used. Thus, the only income that really benefits from indexing is that relatively small range of dollars that moves "backwards" from one tax rate to the next lower one due to bracket adjustment. All the rest of one's income that's in the same bracket this year as last is taxed at the same rate in both years ... whether it be a state's 2%, 4% or 9.3% rate, or the federal's 15%, 25% or 35% rate.
In order to truly index taxes, so that someone with the same income two years in a row will pay less tax in Year 2 by the index rate, say 5%, the method of indexing would need to be done a completely different way. At least three better methods come to mind.
Instead of simply inching up the start of each tax bracket, the brackets would remain the same, after being set legislatively in some "base" year. Then in future years the tax would first be calculated using the same "base year" rates and brackets, and THEN it would be multiplied by an index factor. The index factor would work much like the CPI, except that it would become an ever-decreasing percentage year after year (assuming inflation). For example in Year 1 the index factor would be 1.00000, but in Year 2, assuming inflation of 5.0%, the tax index factor would be 0.95238. Future years' index rates might look something like this: Year 3 = 0.91344, Year 4 = 0.86871, Year 5 = 0.82609, and so on. If someone's taxable income increased each year by exactly the same amount as the rate of inflation, his tax would remain the same year after year. But if his income stayed the same, e.g. $50,000 in each year, then his federal tax would actually go down inversely proportional to inflation.
True indexing could also be accomplished in at least two other ways: One would be to apply an "index" factor not to the tax but to taxable income. Another would be to index the tax rates themselves. I fear, however, that the latter might tempt Congress to raise rates every few years as they appeared to drift steadily lower.
Any proper indexing method could be built into the tax tables, of course, so most people wouldn't have to make the actual indexing calculation. That adjustment would really only have to be made by those (or their tax preparers) who use the tax rate schedules.
“By indexing the tax rates, a California household with unchanged income will pay 5 percent less in State income taxes,” said State Controller and FTB Chair John Chiang.
I don't know if the FTB is too stupid to realize it, or believes everyone else is, but the above sentence simply isn't true for most California taxpayers. Depending on where one's income happens to fall within any of California's first five tax brackets ... 1%, 2%, 4%, 6%, 8% ... the actual reduction in tax on the same year-to-year taxable income ranges from 0% to 8%. And once a taxpayer's income reaches and extends into the state's highest tax bracket of 9.3%, which for a single person starts at $47,055, that touted 5% reduction goes steadily down and almost reaches zero. A single person's 2008 California tax on income of $60k is only 3.2% less than the tax on the same income in 2007; on income of $100k it's only 1.5% less; and on income of $250k it's only 0.5% less.
The so-called federal indexing works the same way and produces equally misleading results. This is because the TAX isn't really indexed at all ... only the START of the various tax brackets is inched up by the prior year's rate of inflation, or COLA, or whatever benchmark is used. Thus, the only income that really benefits from indexing is that relatively small range of dollars that moves "backwards" from one tax rate to the next lower one due to bracket adjustment. All the rest of one's income that's in the same bracket this year as last is taxed at the same rate in both years ... whether it be a state's 2%, 4% or 9.3% rate, or the federal's 15%, 25% or 35% rate.
In order to truly index taxes, so that someone with the same income two years in a row will pay less tax in Year 2 by the index rate, say 5%, the method of indexing would need to be done a completely different way. At least three better methods come to mind.
Instead of simply inching up the start of each tax bracket, the brackets would remain the same, after being set legislatively in some "base" year. Then in future years the tax would first be calculated using the same "base year" rates and brackets, and THEN it would be multiplied by an index factor. The index factor would work much like the CPI, except that it would become an ever-decreasing percentage year after year (assuming inflation). For example in Year 1 the index factor would be 1.00000, but in Year 2, assuming inflation of 5.0%, the tax index factor would be 0.95238. Future years' index rates might look something like this: Year 3 = 0.91344, Year 4 = 0.86871, Year 5 = 0.82609, and so on. If someone's taxable income increased each year by exactly the same amount as the rate of inflation, his tax would remain the same year after year. But if his income stayed the same, e.g. $50,000 in each year, then his federal tax would actually go down inversely proportional to inflation.
True indexing could also be accomplished in at least two other ways: One would be to apply an "index" factor not to the tax but to taxable income. Another would be to index the tax rates themselves. I fear, however, that the latter might tempt Congress to raise rates every few years as they appeared to drift steadily lower.
Any proper indexing method could be built into the tax tables, of course, so most people wouldn't have to make the actual indexing calculation. That adjustment would really only have to be made by those (or their tax preparers) who use the tax rate schedules.
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