Posted in Finance, Accounting and Economics Terms, Total Reads: 71
Definition: Tax Indexing
Tax Indexing involves changing or adjusting the tax rate bracket with the increase or decrease in inflation in the particular country. It is very important aspect in a growing economy where inflation is continuously growing because if tax rate bracket is not changed with the changing inflation rate it can lead to bracket creep.
Bracket creep is a phenomenon where inflation somehow increases the income of an individual and pushes her/him in next tax bracket but there is not increase in the purchasing power of that individual. Thus Tax indexing involves regularly altering the tax brackets. In tax indexing the taxes and the income of an individual is tied with inflation through an index
For example from 2015 to 2016 there is 20% increase in inflation and Mr. X’s salary increased from Rs. 1000000 to Rs. 1200000. Due to the increase in Mr. X salary he now comes in another bracket of income tax return. Somehow the increase in salary has not leaded to increase in his purchasing power but now the percentage of tax has increased. Thus this is why tax indexing is done.
So government should use this criterion so that it does not lead to bracket creep and lead to more problems for the tax payers. Thus this will help in maintaining the purchasing power of the people and also not let government charge high tax rate. But usually it is not possible to change the tax brackets as regularly as change in inflation. Government usually restrains this method as they want to increase the taxes as much as they can while this method reduces the amount that is receipt by the government in the form of taxes.
In United States of America, the standard tax rate is indexed to the inflation.