Tax Reform Has a Hidden Tax Increase

As I am sure you know, the GOP unveiled its tax reform legislation yesterday, with some of the highlights including:

• Reducing the number of tax brackets from 7 to 4. The new brackets are 12%, 25%, 35%, and 39.6%.

• Cutting the corporate income tax to 20%.

• Doubling the standard deduction.

• Creating a new Family Tax Credit consisting of a doubled child tax credit and a new $300 tax credit for each parent and dependent.

• Preserving the mortgage interest deduction for existing homeowners and capping it at $500,000 for new homes.

• Reducing taxes on small business to 25%.

• Getting rid of deductions for state and local income taxes while allowing deductions of up to $10,000 on property taxes.

• Repealing the alternative minimum tax.

• Phasing out the Death Tax over six years.

• Adopting a territorial tax system and providing for repatriation of foreign capital.

Unfortunately, due to Congress’ failure to cut spending, the tax plan will increase the deficit. In addition, the tax plan eliminates most deductions—including the adoption tax credit, the deduction for forgiven student loan interest, the medical expense deduction, as well as personal exemptions. Some have raised concerns that eliminating these deductions could raise taxes on middle-class families. Others say the increase in standard deductions combined with the family tax credit will prevent that from happening.

What few have commented on is the hidden tax increase that could wipe out the Bender’s of the tax plan. The increase comes from the adoption of “chained CPI.” Chained CPI understates the effect of inflation by saying that you are not harmed if inflation makes it impossible for you to afford steak as long as you can buy a hamburger. Use of Chained CPI thus allows the government to take maximum advantage of “bracket creep” where inflation pushes people into higher tax brackets even though their real income has declined as their purchasing power is eroded.  This is going to be a huge problem in coming years since none of the major deductions or exemptions are indexed for infusion and Jerome Powell is likely to follow the easy money policies of his predecessors.

Campaign for Liberty Chairman. Ron Paul explained the hazards of Chained CPI in 2013:

One of the least discussed, but potentially most significant, provisions in President Obama’s budget is the use of the “chained consumer price index” (chained CPI), to measure the effect of inflation on people’s standard of living. Chained CPI is an effort to alter the perceived impact of inflation via the gimmick of “full substitution."

This is the assumption that when the price of one consumer product increases, consumers will simply substitute a similar, lower-cost product with no adverse effect. Thus, the government decides your standard of living is not affected if you can no longer afford to eat steak, as long as you can afford to eat hamburger.

The problem with “full substitution” should be obvious to anyone not on the government payroll. Since consumers did not choose to buy lower-priced beef before inflation raised the price of steak, they obviously preferred steak. So if the Federal Reserve’s policies create inflation that forces you to purchase hamburger instead of steak, your standard of living is lowered.

CPI already uses this sort of substitution to mask the costs of inflation, but chained CPI uses those substitutions more frequently, thereby lowering the reported rate of inflation.

Supporters of chained CPI also argue that the government should take into account technology and other advances that enhance the quality of the products we buy. By this theory, increasing prices signal an increase in our standard of living!

While it is certainly true that advances in technology improve our standard of living, it is also true that, left undisturbed, market processes tend to lower the prices of goods.

Remember the mobile phones from the 1980s? They had limited service, constantly needed charging, and were extremely expensive. Today, almost all Americans can easily afford a mobile device to make and receive calls, texts, and e-mails, as well as use the Internet, watch movies, read books, and more.

The same process occurred with personal computers, cars, and numerous other products. If left alone, the operations of the market place will deliver higher quality and lower prices. It is only when the government interferes with the operation of the market, especially via fiat money, that consumers must contend with constant price increases.

The goal of chained CPI is to decrease the government's obligation to meet its promise to keep up with the cost of living in programs like Social Security. But it does not prevent individuals who have a nominal increase in income from being pushed into a higher income bracket. Both are achieved without a vote of Congress.

Noted financial analyst Peter Schiff correctly calls chained CPI a measurement of the cost of survival. Instead of using inflation statistics as a political ploy to raise taxes and artificially cut spending, the President and Congress should use a measurement that actually captures the eroding standard of living caused by the Federal Reserve’s inflationary policies.

Changing government statistics to exploit the decline in the American way of life and benefit big spending politicians and their cronies in the big banks does nothing but harm the American people.