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avoid the unlegislated erosion of the value of a given provision due to inflation. We see indexation of the tax code--both the rate structure and the base--as essential ingredients to an improved, more equitable,

tax system.

I would be pleased to respond to any questions you have.

Statement of
Tax Policy

Implementing Indexation of the Tax Laws

Issued by the Federal Taxation Division of the
American Institute of Certified Public Accountants

24-860 O 84 9



Statement of Tax Policy 6, issued by the American Institute of Certified Public Accountants, states that the Institute supports the concept of indexing the Internal Revenue Code to adjust for changes in the value of the dollar. That statement presents the issues together with background information on the subject of indexation, including a summary of indexation abroad and in the United States and arguments for and against indexing.

As called for in Statement of Tax Policy 6, a new task force was established to study procedures for implementing indexation of the code. This Statement of Tax Policy results from those studies.


The AICPA recommends that the Internal Revenue Code be indexed to minimize the impact of inflation on the tax system. To implement this recommendation, the Institute specifically suggests that

1. Individual tax brackets and fixed dollar allowances such as deductions, credits, and exemptions be indexed.

2. Corporate tax brackets and fixed dollar allowances be indexed. 3. The basis of assets generally be indexed.

4. Assets and liabilities representing fixed dollar debt not be indexed.

5. A capital maintenance deduction not be provided for business enterprises.

6. Estate and gift tax brackets and fixed dollar allowances be indexed.

7. One readily accepted index be consistently used as the measurement of inflation.


The U.S. economy has been subject to varying degrees of inflation during most of its history. In general, the annual rates of inflation have been relatively modest; consequently, inflation usually has not had a materially adverse effect on our tax system. However, increased worldwide inflation and recent double-digit inflation in the United States has challenged the credibility of our present tax system.

The sustained high level of inflation in recent years has convinced the public of the need to deal with inflation as more than a temporary phenomenon. Most economists, and the population as a whole, anticipate high rates of inflation into the foreseeable future. In our opinion, this mandates that Congress adjust and correct the tax system for inflation. The Institute neither supports nor opposes any particular tax rate structure or percentage exclusion for longterm capital gains. Our only objective in this statement is to preserve the congressionally determined structure from distortions due to inflation which arise after such determination. As discussed in Statement of Tax Policy 6, we have concluded that adjustment for inflation is needed and should be made by indexing the Internal Revenue Code.

Most of the basic provisions of the Internal Revenue Code were enacted at a time when inflation was not a serious problem; consequently, the major features of the code, such as income tax brackets which set marginal tax rates, and exemptions and deductions, are stated in fixed dollar terms. But inflation diminishes the real value of these items and unless they are adjusted, tax burdens will increase at a rate more than proportionate to inflation. This tax increase may be termed an inflation tax.1

The resulting increase in government revenues creates other serious economic problems which are discussed in this statement. Further, because federal income taxes generally are more progressive than state income taxes and because state income taxes generally are more progressive than related local taxes, there tends to be a greater flow of resources to higher levels of government, resulting in a distortion of fiscal balance among federal, state, and local entities. Finally, inflation creates distortion in the distribution of the total tax burden, especially against taxpayers at the lower end of the income scale.

1. Advisory Commission on Intergovernmental Relations, “The Inflation Tax: The Case for Indexing Federal and State Income Taxes” (Washington, D.C.: 1980), p. 1.

As the tax base (total pretax income) expands, federal revenues increase by a greater than proportionate amount. For example, the Congressional Budget Office estimates that without indexation, inflation will increase federal income tax revenues from individuals by over $22 billion in fiscal year 1981 alone.2 A study conducted by the Joint Committee on Taxation showed that government tax revenues rise at 1.65 times the rate of increase in the cost of living. For individual taxpayers, this means that for every 10 percent rise in income, taxes increase an average of 16.5 percent. The difference represents the increase in federal revenues beyond the proportionate growth in income. The net effect is a tax increase resulting from inflation rather than from legislative action.3

Capital Formation

During periods of inflation, businesses have difficulty obtaining the capital necessary to modernize plant and equipment. Committing funds to the development of new inventions or business undertakings entails the acceptance of risks, but under our present system, the interaction of inflation and taxation diminishes the reward against which these risks are measured.

Many businesses seek to price their products and engage in activities so they can replace income-producing assets as they become worn or obsolete and earn a return on their original investment. If businesses underestimate the cost of replacing old assets, they will not have sufficient funds left over to finance expansion and new investments. It appears this has been happening. If one looks at the figures for the entire economy, unadjusted for inflation, business profits appear adequate to replace existing capacity while still leaving substantial amounts for new investment. However, when business costs are adjusted for inflation, real profits are seen to decrease greatly. The problem is made worse because taxes are imposed on income unadjusted for inflation, rather than on real economic profit. Thus, after adjustment for inflation, the pool of net savings available for new capital investment has been decreasing steadily.

The AICPA has addressed one aspect of capital formation in Statement of Tax Policy 7, Analysis of Capital Cost Recovery Pro

2. Congress of the United States, Congressional Budget Office, "Indexing the Individual Income Tax for Inflation" (Washington, D.C.: 1980), p. X.


3. U.S., Congress, Senate, Committee on Finance, Hearing before the Subcommittee on Taxation and Debt Management Generally, 95th Congr., 2d sess., April 1978, statement of Senator Robert P. Griffin.

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