With the new tax law (The Tax Cuts and Jobs Act of 2017 or TCJA), the tax brackets were reduced so many would recognize greater cash in their wallet at the end of the day. However, what was not highly publicized was that the TCJA mandated a change from the Consumer Price Index for All Urban Consumers (CPI-U) to the Chained Consumer Price Index for All Urban Consumers (chained CPI). The impact of this tax law change is not beneficial to taxpayers but will be to tax revenues in the future.
The chained CPI is a slower method to calculating inflation. Instead of measuring higher prices, like for food or other consumer items, the chained CPO measures consumer responses to higher prices rather than simply measuring the higher prices. What does this mean?
For example, let’s say in 2017 that coffee was $10/pound and tea was $10/pound. Let’s assume the consumer likes coffee more than tea. Therefore in 2017 the consumer bought 10 pounds of coffee and two pounds of tea. Now in 2018 assume coffee jumped to $15/pound and tea went up just to $11/pound. In this case, the consumer decides to buy more tea than coffee because it is cheaper, so the consumer instead bought five pounds of coffee and seven pounds of tea. Overall, the consumer still bought the same amount of caffeinated beverages but pricing changed the mix, it also assumes that there would be no substitutes for the higher costs of coffee and tea to let’s say diet Coke. The theory of chained CPI is that most would react in a similar manner – they would alter their spending to compensate for increases.
Here’s how the "normal" CPI calculations based solely on price increases would look:
(10 x 15) + (2 x 11)/(10 x 10) + (2 x 10) = 1.4333
In the above example, it assumes that the amount purchased is equal from year to year and does not take into account consumer actions due to price increase. The denominator is the base year for comparison (in this case 2017).
So the chained CPI calculations would reflect the actual change in the consumer’s behavior and would be:
(5 x 15) + (7 x 11)/ (10 x 10) + (2 x 10) = 1.267
The chained CPI is based on actual amounts bought, multiplied by the cost per item, and divided by the base year, again 2017. As can be seen, the CPI would show an increase of 4.3%. A chained CPI would show only a 2.7% increase.
Therefore, by having the tax rates tied to chained CPI, employee salaries will likely rise greater (assuming the average range of 2.8%-3.2% salary budget increases are the norm in the near future) than the chained CPI, low and behold, employees will be situated in a higher bracket. The impact on tax payers will eventually override the initial benefits of the tax cuts as those moving to the new brackets will pay as much or possibly more than under the previous tax law. It will not likely be noticed in the near future, but down the road, employees could really notice the impact of taxes paid.
Therefore, it is important the HR and payroll professionals be prepared to answer questions by employees, as many will be checking their paystub and wonder why the take home is less than they expected. And for those who are nearing retirement, social security is tied to chain CPI.
Finally, the IRS has the annual inflation figures for 2019. The amounts include 2019 tax brackets, the standard deduction, alternative minimum tax amounts, among others. The amounts are based upon Consumer Price Index figures released by the U.S. Department of Labor. Click here for the tables and amounts.
Source: Forbes 9/14/18, 10/13/13