As Americans navigate through their financial lives, many are aware of the inflation adjustments that are made to various thresholds each year. These adjustments play a crucial role in allowing households to keep up with the rising cost of living. For instance, Social Security benefits, federal income tax brackets, and contribution limits to 401(k) plans are examples of thresholds that are adjusted for inflation annually. However, it’s worth noting that not all thresholds receive the same treatment. Some critical thresholds, such as the federal minimum wage, do not get an annual inflation adjustment. The decision of what gets inflation-indexed and what doesn’t largely depends on the lawmakers who drafted the legislation, creating a diverse landscape of indexed and non-indexed thresholds.
One particularly impactful non-inflation-indexed threshold is the federal minimum wage, which has remained stagnant at $7.25 per hour since 2009. This marks the longest period in history without an increase from Congress, resulting in a significant loss of value due to inflation. According to the Economic Policy Institute, the minimum wage has lost 29% of its purchasing power since 2009, making it less valuable than it has been in over six decades. Despite this, only a small percentage of hourly workers in the U.S. are currently paid at or below the federal minimum wage, with the majority of states and localities implementing higher minimum wages to address the issue.
Social Security Benefits
Another threshold that hasn’t seen an inflation adjustment is the taxation of Social Security benefits. While the federal government started taxing Social Security benefits in 1984, the dollar thresholds for taxation have never been updated for inflation. Consequently, as Americans’ incomes have increased over time, more beneficiaries have found themselves subjected to federal income tax on their benefits. This trend is evidenced by the fact that the percentage of people paying taxes on their Social Security benefits has risen significantly over the years, highlighting the impact of non-indexed thresholds on retirees.
In the realm of investments, becoming an accredited investor requires meeting certain financial thresholds, such as a minimum net worth or annual income. These thresholds were put in place to ensure that investors are financially savvy enough to bear the risks associated with private investments like hedge funds and private equity. While the requirements were established in the early 1980s, they have remained unchanged since then. This lack of inflation adjustment has led to a substantial increase in the number of households qualifying as accredited investors, raising questions about the effectiveness and relevance of these thresholds in today’s financial landscape.
Similarly, many tax breaks and deductions are indexed for inflation, while others, like the deduction for home mortgage interest, are not. Changes in tax laws have further complicated the landscape, as seen with the reduction of the cap on home mortgage interest deductions from $1 million to $750,000. Additionally, certain taxpayers are subject to a 3.8% surtax on investment income, with income thresholds that have not been adjusted for inflation. This has resulted in more taxpayers being affected by the surtax over time, irrespective of their real income growth, posing challenges for high-income households.
The presence of non-inflation-indexed thresholds in the American financial system has wide-ranging implications for households and investors alike. From stagnant minimum wages to outdated investor requirements, these thresholds can create financial challenges and disparities, impacting individuals’ purchasing power and financial well-being. As lawmakers and policymakers consider reforms and updates to existing thresholds, it is essential to assess the broader impact of these adjustments on various segments of the population, ensuring a fair and equitable financial landscape for all Americans.