The Consumer Price Index is involved in payroll topics like minimum wage, benefits, and the federal tax brackets.
If you have ever tuned in to a business news channel, you have probably heard someone mention the Consumer Price Index at some point. Recently, the high rate of inflation is a topic of importance and concern. Inflation has risen 7% over the past year. That’s the highest since 1982. I was seven in 1982, so for me, inflation meant keeping the tires in my BMX bicycle filled with air as I hopped off a curb with reckless abandonment and no helmet. Hey, it was the 80s.
What is the Consumer Price Index?
Inflation, as it relates to economics, refers to a general increase in the prices of goods and services in an economy. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods. The U.S. Bureau of Labor Statistics posts the CPI each month for a number of geographic regions in the United States. Other regions are only measured twice a year or annually.
The indexes cover the following two population groups – CPI for All Urban Consumers (CPI-U), which covers 93% of the U.S. population, and CPI for Urban Wage Earners and Clerical Workers (CPI-W), which covers 29% of the U.S. population. In January 2022, the BLS announced a CPI annual gain of 7.0%. This was the largest 12-month increase in 40 years.
For the purposes of payroll, the CPI is important for topics such as minimum wage and benefits.
Minimum wage rates and the CPI
On January 1, 2022, the minimum wage rate increased in about 21 U.S. states. A number of states and localities have their own minimum wage rate laws. The federal minimum wage rate for the nation remains at $7.25 per hour. However, many states have already passed laws that incrementally increase the minimum wage rate in the state over a period of time. Typically, after the initial increases, there are annual adjustments to the minimum wage rate. And primarily, those annual adjustments are based on the CPI.
Alaska’s minimum wage rate did not change from $10.34 per hour in 2022, even though the rate is adjusted based on inflation. State law requires minimum wage rate adjustments using the CPI for urban consumers in the Anchorage metropolitan area for the preceding calendar year. The Urban Alaska CPI-U decreased by 1.1% in 2020. According to the Alaska Department of Labor and Workforce Development, because there was no inflation in 2020, the minimum wage rate remains unchanged in 2022.
Arizona’s 2022 minimum wage rate increased to $12.80 per hour. The $0.65 increase was based on the increase in inflation between August 2020 and August 2021, as published in the BLS’s CPI. So, for some states, the decision on which CPI month to view could mean differences in the minimum wage increase. Alaska’s measurement resulted in no increase. Arizona’s, on the other hand, did.
While California has its own minimum wage laws, more than 40 localities in the state have minimum wage laws too. For certain localities, the rate is based on the CPI. For example, the minimum wage in Anaheim is currently $18 per hour. Measure L requires a $1 per hour increase in the minimum wage rate, from $15 per hour in 2019 through 2022. Beginning in 2023, any rate adjustments will be based on the CPI. The minimum wage rate in Los Angeles is already based on the CPI and is currently $16.04 per hour. San Francisco also bases any minimum wage rate adjustments on the CPI. The city’s current rate is $16.32 per hour, effective July 1, 2021. San Francisco uses the calendar year to calendar year change in the CPI to calculate any increases.
This is important to employers for payroll because there are a lot of minimum wage rate changes to keep up with. Not all states and localities use the same CPI measurement to make these determinations. A multi-state employer in the hotel or service industry may need to be aware of multiple tax jurisdictions and adjust payroll software or other payroll methods in place to make sure all employees are paid according to the minimum wage rate in effect. Also, employers are typically required to post or announce minimum wage rate changes in an obvious place or way, so that all employees are aware of the new rate in place. Noncompliance can result in penalties.
Annual benefit adjustments and the CPI
At the federal level, the CPI is used for several annual benefit adjustments. Typically, in October and November, the IRS announces a number of payroll-related tax inflation adjustments for the following calendar year. For example, on November 21, 2021, the IRS announced several items that included an increase from $270 to $280 for the monthly limitation for the qualified transportation fringe benefit and monthly limitation for qualified parking expenses. And the dollar limitation for employee salary reductions for contributions to health flexible savings arrangements increased to $2,850 (annually). The IRS uses the CPI to make these annual determinations.
The Social Security Administration (SSA) uses the Cost of Living Adjustment (COLA) to determine the Social Security taxable wage base for the following calendar year. COLAs are based on the CPI-W. The 2022 Social Security taxable wage base is $147,000.
Understanding when and how the IRS and SSA use the CPI for annual benefit adjustments is important, so payroll departments and professionals can properly prepare systems and programs for the following calendar year. Errors in paychecks can mean adjustments regarding tax deposits and filings that can be time-consuming and may also result in penalties.
Federal tax brackets and the CPI
Each year, the IRS adjusts tax brackets for COLA to calculate federal tax liability. The federal income tax brackets are located in IRS Publication 15-T, Federal Income Tax Withholding Methods. This publication also contains other information for automated and manual payroll systems. For some time, the brackets were part of Publication 15 (Circular E), Employer’s Tax Guide. However, after the IRS significantly revised Form W-4, Employee’s Withholding Certificate, in 2020, the IRS began putting the bracket tables in Publication 15-T.
To make adjustments to the federal tax bracket tables, the IRS looks at the CPI-U from September to August and compares that average with the one for the preceding 12 months. The IRS says that making these adjustments from the CPI has the effect of preventing taxpayers from being moved into higher marginal tax brackets for increases that do not exceed inflation.
The CPI-U also affects the standard deduction amount ($12,950 in 2022 for single and married filing separately). This was also the case for personal exemptions, but such allowances are not permitted through calendar year 2025. This is because of a provision from the December 2017 Tax Cuts and Jobs Act (P.L. 115-97). The IRS website has information about the changes from that law.
How payroll professionals can keep up with changes and plan ahead
Payroll is just about everywhere in the daily lives of individuals and businesses, and there’s a lot of information to keep up with. You can refer to my blogpost on 2022 payroll trends for more on this topic.
Knowing that the IRS will begin making calculations for adjustments to its annual federal tax bracket tables and the standard deduction after the August CPI-U is published each September is helpful for employers and payroll professionals. Planning ahead for the next calendar year is always a good idea, so set a reminder on your calendar. A lot of payroll departments start to gear up for the busy “year-end” period in the late summer to early fall. This can help for a smoother transition for the next calendar year.