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. Federal Tax Brackets

    The Federal tax brackets are the tax ranges set by the Internal ...
  2. Marginal Tax Rate

    A marginal tax rate is the amount of tax paid on an additional ...
  3. Margin Creep

    Margin creep has a couple of meanings in finance. In either case, ...
  4. Lifestyle Creep

    Lifestyle creep occurs when an individual's standard of living ...
  5. Tax Planning

    Tax planning is the analysis of a financial situation or plan ...
  6. Effective Tax Rate

    The effective tax rate is the average rate at which an individual ...
Related Articles
  1. Taxes

    Breaking Down Taxes For Different Income Brackets

    Here is a useful rundown of how much you will pay in taxes based on your income.
  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. Retirement

    Making Sure Assets Go to Non-Spousal Heirs

    Save non-spousal heirs taxes on your estate by moving your assets from a qualified plan.
  5. 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 ...
  6. Taxes

    Anticipating Trump: How to Adjust Tax Planning Now

    President-elect Trump's proposed tax plan means your tax situation could change next year. What to do now.
  7. Retirement

    How the Tax Bill Might Impact Your Retirement Income

    There has been much discussion about who is benefiting most from the new tax bill, but no one is discussing its effect on your retirement income.
  8. Insights

    What is Fiscal Policy?

    Fiscal Policy how governments adjust taxes and spending to moderate the economy. Fiscal Policy is the sister strategy to monetary policy, through which a central bank influences a nation's money ...
  9. Taxes

    Making Sense of the 2017 Tax Changes

    Here is a brief overview of some of the changes introduced by the Tax Cuts and Jobs Act of 2017, and how they may affect your taxes.
  10. 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.
Trading Center