Should you be concerned about bracket creep from inflation?
The US inflation rate rose to 6.8% in 2021, its highest since 1982. While some of this may be transitory, experts have varying opinions. In this blog, we’d like to discuss something called Bracket Creep, which may affect some of our clients and readers.
Bracket creep is a situation where inflation pushes income into higher tax brackets. The result is an increase in income taxes but no increase in real purchasing power. This is a problem during periods of high inflation, as income tax codes typically take longer to change than the rate of inflation. (Investopedia.com)
We describe bracket creep as akin to walking up an escalator that is going down. Sometimes it’s hard to keep up and simply stay in the same place, let alone make forward progress on your financial goals. So, it’s certainly something which should draw your attention.
Some tax rates and limitations are adjusted for inflation. As a dollar loses value or becomes worth less, tax rates and limitations should reflect that change in value. The problem is that some tax rates and limitations are not adjusted and remain at a fixed dollar amount. The effect is as taxable income rises and buys less, you pay more tax. As an example, capital losses are deductible up to $3,000. That limit was established many years ago and has not been adjusted for inflation. The result is that a much larger capital loss should be deductible to keep up with inflation.
The best way to prepare for bracket creep and inflation is to pay attention. Pay attention to salary raises as the cost of goods and services rises. Pay attention to your taxable income ahead of filing a return so you have the ability to mitigate bracket creep.
Fast-growing states are likely to be hit hardest by bracket creep. One of the fastest-growing states is Texas which has no state income tax. No state income tax, no problem. But, a state like Georgia or South Carolina, which does have income tax will be affected.