Each year, the U.S. Internal Revenue Service (IRS) adjusts tax brackets for changes in the cost of living to calculate federal tax liability. Because the U.S. economy typically faces inflation each year, the IRS adjusts tax brackets upward.
Tax brackets represent the dollar amount that stratifies taxable income. Tax rates change in the U.S. progressive tax system; tax brackets provide limit values with which the tax rate changes. For instance, if a single individual earned a taxable income of $9,700 in 2020, he faces a 10% tax rate for federal income purposes, resulting in a total tax of $970. However, if an individual earned $36,900, he pays 10% on $9,700 and 12% on the remaining $27,200, resulting in a federal tax liability of $4,234.
Every year, the IRS makes adjustments to personal exemption, standard deduction, tax brackets and other tax credits to account for changes in the cost of living. Even though U.S. tax rates may remain the same, changing tax brackets, deductions and credits affects the effective tax rate faced by individuals and corporations.
In 2014, the IRS changed all tax brackets across all filing statuses, thus changing the effective tax rate. For example, from 2013 to 2014 for single filing status, the IRS adjusted the 10% tax bracket cutoff value from $8,925 to $9,075; the 15% tax bracket cutoff value from $36,250 to $36,900; and the 25% tax bracket cutoff value from $87,850 to $89,350. For a single filing status, these changes represent an average increase of approximately 1.7% for tax brackets, which was close to the U.S. inflation rate of 1.6% in 2014.