DEFINITION of 'Bracket Creep'

A bracket creep is a situation wherein inflation pushes income into higher tax brackets. The result is an increase in income taxes but no increase in real purchasing power.

BREAKING DOWN 'Bracket Creep'

This is a problem during periods of high inflation, as income tax codes typically take a longer time to change.

Why Bracket Creep Is a Concern

Bracket creep can occur on an ongoing basis if the overall economy grows yet taxpayers do not see substantial increases to their income. In other words, they are charged more taxes without realizing any real improvement on their actual income. This can create a financial drag on the economy as taxpayers spend more money on taxes though they have not reaped any benefits of a tangibly higher salary rate.

Salaries may see nominal increases where the take-home pay shows no real change; however, if the Internal Revenue Service has not made adjustments to the brackets, it can force taxpayers into paying higher rates. Bracket creep essentially increases taxes for individuals without any legislation for a tax increase.

The loss of money to this form of taxation can amount to trillions of dollars over a twenty-year period. This can be particularly challenging for individuals and households in lower income segments because the taxes they must pay can escalate rapidly the larger the salary they begin to earn.

Furthermore, there may be expenses, such as rent, that are floating and prone to increase faster than income. There is some debate over how bracket creep affects taxpayers in the higher-earnings brackets, because of the higher tax rates they may already be charged, the push to an even pricier bracket can drastically reduce their net income. This, in turn, can encourage the use of tax planning services in order to curtail the progression of bracket creep.

The IRS and Bracket Creep

Typically, the IRS relies on the Consumer Price Index to scale its adjustments by taking into account base year versus current year indicators. The calculation for the adjustments can be made multiplying the base value of a tax parameter by the current Consumer Price Index, then dividing that by the CPI of the base year.

There are other ways the IRS may adjust the brackets, such as measuring the average wage growth in order to get a sense of inflation. As bracket creep affects personal wealth, there is often debate regarding tax cuts and how adjustments are made to tax brackets to better account for the increases.

RELATED TERMS
  1. Tax Indexing

    Tax indexing is the adjustment of the various rates of taxation ...
  2. Incremental Tax

    An incremental tax is a tax that increases in increments based ...
  3. Federal Tax Brackets

    The Federal tax brackets are the tax ranges set by the Internal ...
  4. Price Creep

    A price creep occurs when either an individual or a group gradually ...
  5. Fiscal Drag

    Fiscal drag refers to a situation where a government's net fiscal ...
  6. Bracketed Buy Order

    Bracketed buy order refers to a buy order that has a sell limit ...
Related Articles
  1. Taxes

    Capital Gains Tax Cuts For Middle Income Investors

    Find out how TIPRA plans to slash taxes for those in the 10-15% tax bracket.
  2. Taxes

    How to Reduce Risk With Tax Diversification

    Is your retirement income adequately diversified from a tax standpoint?
  3. Taxes

    Comparing Long-Term vs. Short-Term Capital Gains Tax Rates

    An understanding of the taxation of long- and short-term capital gains is crucial to ensuring the benefits of your investment portfolio outweigh the costs.
  4. Taxes

    What's a Marginal Tax Rate?

    The marginal tax rate is based on a progressive tax system, where tax rates for an individual will increase as income rises. This method of taxation aims to fairly tax individuals based upon ...
  5. Taxes

    Trump’s Upper-Middle-Class Tax Increase

    While the rich save on taxes, some upper-middle-class couples and singles may find themselves in a higher tax bracket under President-Elect Trump’s plan.
  6. Taxes

    Emergency Funds That Are Right For Your Tax Bracket

    How much you need to sock away depends on how much money you'll need down the road.
  7. Taxes

    Clinton vs. Trump: What Happens to Your Income Taxes?

    The Clinton and Trump income tax proposals differ, but neither is revolutionary. The distinctions are in the details: tax brackets, credits vs. deductions for childcare.
  8. Taxes

    How Income Taxes Could Change Under President Trump

    Different tax benefits for families, changes in tax brackets and what could happen to mortgage interest deductions with President Trump and a new Congress
  9. Taxes

    5 Ways to Reduce Your Taxes After a Windfall Gain

    Windfall income is a welcome padding to any bank account, but plan for the government's share before you start spending.
  10. Retirement

    Don't Miss This Retirement Tax-Saving Window

    Many retirement planners view the years between age 59½ and 70½ as a “sweet spot” for their clients’ taxes. Here’s why and how to take advantage of it.
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center