The Tax Foundation

November 1, 2003

Federal Income Taxes and the Cost of Living

by J. Scott Moody and David Hoffman

Special Report No. 125

Executive Summary
In 1972, Congress created the Federal Wage System (FWS) to ensure that comparable federal employees were paid salaries that would enable them to maintain comparable standards of living. Put simply, the FWS’s mission is to adjust federal compensation for differences in cost of living. For example, a nurse working for the Department of Defense in San Diego, California, earns $43,557 at grade 7, step 1. If she moved to San Antonio, Texas, she would earn $36,781.

Even though the dollar amount of her San Antonio salary is more than 15 percent lower, it could not be called economically lower because she can maintain the same standard of living as in San Diego, including the purchase of housing and all the other goods and services included in a survey of the cost of living by the Department of Defense.

There is one important respect, however, in which the move to San Antonio would be an economic plus: the price of the federal government would go down. Unlike federal employees’ salaries, the federal income tax code has no preset provisions — standard deduction, exemption, tax bracket, etc. — that are adjusted for geographic differences in the cost of living. As a result, a single government nurse with no dependent children in San Diego pays much higher federal income taxes than a nurse with the same standard of living in San Anto-nio: $3,844 instead of $2,827.

This report examines how the federal individual income tax creates different tax liabilities between taxpayers with the same standard of living. The data lead to the conclusion that our progressive federal income tax code overcharges people who live where the cost of living is high, where salaries are higher in nominal terms but not in their purchasing power. Of course, the flip side of this observation is that our current federal income tax favors taxpayers who live in a low-cost area, leaving them with a higher after-tax standard of living.

Attached Files