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

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 earns a taxable income of $9,950 in 2021, they face a 10% tax rate for federal income purposes, resulting in a total tax of $995. However, if an individual earned $36,900, they pay 10% on $9,950 and 12% on the remaining $26,950, resulting in a federal tax liability of $4,229.

Inflation Adjustments

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.

For tax year 2021, the IRS updated all tax brackets across all filing statuses, thus changing the effective tax rate. For example, the 10% tax bracket cutoff increased from $9,875 for 2020 to $9,950 for 2021, an increase of roughly 0.8%.