WASHINGTON -- With all the talk of tax reform recently, a significant change in tax law that begins with the New Year -- indexing - has been virtually overlooked.
Starting Tuesday, personal income tax rates will be adjusted to reflect inflation, meaning anyone whose salary is raised up to 4.08 percent during 1985 will not face any income tax increase.
Previously, people often were bumped into higher tax brackets, which increase progressively from 11 to 50 percent, just because their salaries kept pace with inflation.
The effect of indexing is as significant as any of the tax simplification proposals announced by Treasury Secretary Donald Regan last month. More importantly, it is already part of the nation's tax code -- something Regan's reform proposals may never become.
The new indexing law will protect most taxpayers from the costly 'bracket creep' of the past by widening the tax brackets by 4.08 percent and by increasing the standard deduction and personal exemptions by like amounts. The adjustments will be reflexed in taxes withheld from paychecks.
However, a simultaneous increase in Social Security payroll taxes will offset part, and in some cases all, of the savings from tax indexing in 1985.
'We think that Jan. 1 is a landmark date for taxpayers,' said David Keating, executive vice president of the National Taxpayers Union. 'When indexing passed in 1981, most opponents thought it would never see the light of day. And here it is.'
Indexing is the final stage of President Reagan's tax cut program that Congress passed in 1981. It was designed to cut tax rates by approximately 25 percent over a three-year period and then to protect the cuts from being eroded by inflation.
But opponents have complained indexing is too costly, particularly during times of high budget deficits.
The nonpartisan congressional Joint Tax Committee estimates taxpayers nationwide will save over $5 billion in taxes in fiscal year 1985. That means the government will be $5 billion further away from narrowing the deficit.
Over the long term, indexing becomes more costly, rising to $16.2 billion in 1986, $29.7 billion in 1987, $45.5 billion in 1988 and $63.4 billion in 1989, for a five-year revenue loss of more than $160 billion.
Sen. William Armstrong, R-Colo., author of the indexing law, said it will prevent Congress from allowing inflation 'to do the dirty work of raising taxes.
'If members of Congress want to raise taxes, they will have to vote to do so,' he said.
In addition to the income tax brackets being widened, the personal exemption for each taxpayer increases 4.08 percent from $1,000 to $1,040 beginning Jan. 1.
And the standard deduction -- the income threshhold under which no taxes are collected -- will rise from $2,300 to $2,390 for single taxpayers; from $3,400 to $3,540 for married taxpayers filing jointly; and from $1,700 to $1,770 for married taxpayers filing separately.
The Treasury Depatment estimates that a family of four with an adjusted gross income of $31,686 that files a joint income tax return would save about $85 in 1985 because of indexing and $1,863 through 1989. Without indexing, that family would have faced a tax increase of 2.7 percent in 1985.
The indexing rate will vary in subsequent years depending on inflation.
While the maximum savings from tax indexing will be 4.08 percent in 1985, the Internal Revenue Service cautions that not all taxpayers will receive the full benefit.
For example, if a person's salary increase is not enough to bump him into a higher tax bracket under prior law, he's not going to benefit from the widening of the tax brackets. But he will still share in the savings from the larger personal exemption and the bigger standard deduction.
The Treasury Department also has instituted a technical change in the way the tax withholding tables are calculated that could slightly alter the benefits of indexing.
And finally, while indexing will soften the income tax bite this year, Social Security payroll taxes will increase by as much as $259.20 in 1985, offsetting the entire tax break in some cases.
The payroll tax for workers is scheduled to rise from 6.7 percent to 7.05 percent on Jan. 1 and the maximum earnings subject to Social Security taxes, now $37,800, will increase to $39,600.
