Indexing the Tax System

The newspapers tell us that inflation is running at about 14 per cent per annum. The effect of this on the buying power of Americans is disastrous, but at least it is commonly recognized. It can be measured with every consumer purchase. However, inflation has an even more insidious effect on the real earnings of Americans: the tax windfall which accrues to the government through “bracket creep.” Unfortunately, this effect is not commonly understood—because it is hidden, and because many people in government have a personal interest in seeing it continue. Fortunately, there is a solution: indexing.

Bracket creep works something like this. Say a family of four earns $15,000 a year; it pays $1,385, or about 9.2 per cent, in federal income tax. If, in the following year, inflation runs at 7 per cent and wages are raised to keep pace, that $15,000 income would rise to $16,050. The family’s buying power would so far remain the same. But because of the increase in wages, the family would find that its tax bill had risen to $1,613, or approximately 10 per cent of its income. The 7 per cent raise, a merely inflationary raise, had pushed the family into a tax bracket with higher marginal rates. Its real buying power had actually decreased.

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Donald J. Senese

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The newspapers tell us that inflation is running at about 14 per cent per annum. The effect of this on the buying power of Americans is disastrous, but at least it is commonly recognized. It can be measured with every consumer purchase. However, inflation has an even more insidious effect on the real earnings of Americans: the tax windfall which accrues to the government through “bracket creep.” Unfortunately, this effect is not commonly understood—because it is hidden, and because many people in government have a personal interest in seeing it continue. Fortunately, there is a solution: indexing.

Bracket creep works something like this. Say a family of four earns $15,000 a year; it pays $1,385, or about 9.2 per cent, in federal income tax. If, in the following year, inflation runs at 7 per cent and wages are raised to keep pace, that $15,000 income would rise to $16,050. The family’s buying power would so far remain the same. But because of the increase in wages, the family would find that its tax bill had risen to $1,613, or approximately 10 per cent of its income. The 7 per cent raise, a merely inflationary raise, had pushed the family into a tax bracket with higher marginal rates. Its real buying power had actually decreased.