Legal Definitions - bracket creep

Bracket creep is a phenomenon in progressive tax systems where individuals or households are pushed into higher income tax brackets, and thus pay a larger percentage of their income in taxes, without necessarily experiencing a real increase in their purchasing power. This typically occurs due to inflation or nominal income growth when tax bracket thresholds are not regularly adjusted to keep pace with these economic changes.

• Example 1: Inflation and Cost-of-Living Adjustments

  Imagine an employee whose annual salary is $60,000. Each year, they receive a 2% cost-of-living adjustment (COLA) to help their income keep pace with inflation. If the government's income tax brackets are not also adjusted upwards by 2% each year, this employee might find that their nominal income increase pushes them into a higher tax bracket. For instance, if the top of the 15% tax bracket is $60,000, and their COLA raises their salary to $61,200, a portion of their income will now be taxed at a higher rate, say 20%. Even though their *real* purchasing power might not have significantly improved (because the COLA only matched inflation), they are paying a larger percentage of their income in taxes due to bracket creep.

• Example 2: Nominal Wage Growth from a Promotion

  Consider a professional who earns $80,000 annually and receives a significant promotion that increases their salary to $100,000. While this is a substantial raise, if the tax bracket thresholds have remained static for several years, a larger portion of their new income might fall into a higher tax bracket. For example, if income between $75,000 and $95,000 is taxed at 22%, and income above $95,000 is taxed at 24%, the portion of their raise above $95,000 will be taxed at the higher 24% rate. This means that while they are earning more, the effective tax rate on their overall income has increased, reducing the net benefit of their raise more than if the tax brackets had been adjusted to reflect general economic growth and inflation.

• Example 3: Unindexed Tax Brackets Over Time

  In a country where tax bracket thresholds are not automatically indexed to inflation, a worker starting their career at $45,000 might see their salary gradually increase to $75,000 over fifteen years due to regular raises and general economic wage growth. If the tax brackets from fifteen years ago are still largely in effect, that worker will have likely moved through several tax brackets, paying a progressively higher percentage of their income in taxes. Even if their *real* income (adjusted for inflation) has only modestly increased over that period, the lack of adjustment to the tax brackets means they are experiencing bracket creep, leading to a higher effective tax rate on their earnings over time.