Why Is Indexing Important to Taxpayers?

Tax laws evolve to account for economic changes like inflation. Without adjustments, taxpayers could end up paying more simply because their income rises with inflation rather than an actual increase in purchasing power. Indexing ensures tax burdens remain fair over time.

Governments use indexing to modify various aspects of the tax code, preventing inflation from eroding deductions, exemptions, and contribution limits. These adjustments help maintain the intended benefits of tax policies while protecting taxpayers from unintended financial strain.

Adjusting Tax Thresholds

Tax brackets determine how much of a person’s income is taxed at different rates. Without adjustments, inflation can push taxpayers into higher brackets even if their real purchasing power hasn’t changed. This “bracket creep” results in people paying more in taxes despite their income only keeping pace with rising costs. To counteract this, tax thresholds are indexed to inflation.

In the United States, the IRS adjusts federal income tax brackets annually based on the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). For 2024, the top tax rate of 37% applies to income exceeding $609,350 for single filers and $731,200 for married couples filing jointly, up from $578,125 and $693,750 in 2023. These adjustments prevent inflation-driven income increases from pushing taxpayers into higher brackets.

Indexing also affects the Alternative Minimum Tax (AMT) exemption. The AMT ensures high-income earners pay a minimum level of tax. In 2024, the exemption is $85,700 for single filers and $133,300 for married couples filing jointly, up from $81,300 and $126,500 in 2023. Without these adjustments, more middle-income taxpayers could unintentionally fall under the AMT’s scope.

Recalibrating Deductions

Tax deductions lower taxable income, reducing the amount individuals owe. Without periodic adjustments, inflation would erode their value.

The standard deduction, which allows taxpayers to reduce their taxable income without itemizing expenses, is one example. For 2024, the standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly, up from $13,850 and $27,700 in 2023.

Certain itemized deductions also adjust. Medical expense deductions allow taxpayers to deduct qualifying healthcare costs exceeding 7.5% of their adjusted gross income (AGI). While the threshold remains fixed, the expenses themselves—such as long-term care premiums—are indexed annually. In 2024, the deductible limit for long-term care insurance premiums ranges from $470 for those under 40 to $5,880 for individuals 71 and older.

Deductions tied to education expenses also benefit from indexing. The student loan interest deduction, which allows taxpayers to deduct up to $2,500 in interest paid on qualified loans, phases out at higher income levels. These phase-out thresholds increase annually. For 2024, the phase-out begins at $75,000 for single filers and $155,000 for married couples filing jointly.

Modifying Personal Exemptions

Personal exemptions once played a significant role in reducing taxable income, offering a fixed deduction for each taxpayer and their dependents. However, the Tax Cuts and Jobs Act (TCJA) of 2017 eliminated personal exemptions through 2025, replacing them with an expanded standard deduction and enhanced child tax credits. Unless Congress extends this provision, personal exemptions are set to return in 2026.

While personal exemptions are currently suspended, other inflation-adjusted provisions serve a similar purpose. The Child Tax Credit (CTC) provides up to $2,000 per qualifying child in 2024, with $1,600 refundable for lower-income taxpayers. The Earned Income Tax Credit (EITC), designed to support low-to-moderate-income workers, adjusts annually based on wage growth. For 2024, the maximum EITC for a family with three or more children is $7,830.

Additional credits, such as the Credit for Other Dependents (ODC), help taxpayers who support non-qualifying children or elderly relatives. The ODC provides a non-refundable $500 credit per dependent.

Aligning Retirement Contribution Limits

Retirement savings accounts provide tax advantages that help individuals build financial security. Without periodic adjustments, inflation would erode the effectiveness of these benefits. The IRS annually increases contribution limits for tax-advantaged retirement accounts such as 401(k) plans, IRAs, and SIMPLE IRAs.

For 2024, the annual contribution limit for 401(k), 403(b), and most 457 plans has risen to $23,000, up from $22,500 in 2023. Catch-up contributions for individuals aged 50 and older allow an additional $7,500, bringing the total possible deferral to $30,500. Traditional and Roth IRAs also see periodic increases, with the 2024 contribution cap set at $7,000, up from $6,500 the previous year.

Indexing for Capital Gains

Taxation on capital gains can significantly impact investors, particularly when inflation distorts the real value of their returns. Without adjustments, individuals may find themselves paying taxes on gains that merely reflect rising prices rather than actual increases in wealth.

Long-term capital gains tax rates in the U.S. are structured to encourage investment, with rates of 0%, 15%, or 20% depending on taxable income. These income thresholds are adjusted annually. For 2024, the 15% rate applies to single filers earning between $47,025 and $518,900, while the 20% rate starts at incomes above $518,900.

The exclusion for gains on the sale of a primary residence is another area where indexing plays a role. Under current law, single filers can exclude up to $250,000 of capital gains from taxation, while married couples filing jointly can exclude up to $500,000. These figures have remained unchanged since the late 1990s, but discussions around indexing this exclusion to inflation have emerged as housing prices continue to rise. If implemented, such adjustments would prevent homeowners from facing unexpected tax burdens when selling properties that have appreciated primarily due to inflation.