You’re glad you finally got the long-awaited raise. Great news, until you realize you don’t really have much more left to spend despite the raise. This phenomenon is due to “cold creep”. Find out here how different tax brackets and inflation can affect your salary.

Depending on factors such as where you live and the amount of your salary or wages, your income is subject to income tax. The more you earn, the more you will pay if your income is taxed in a country with progressive income tax rates. In countries with fixed income tax rates, all income is taxed at the same flat rate.

Your income in fractions: an example

But how does cold progressivity affect your tax situation? Let’s take a small example to illustrate how “tranche increase,” also called “cold progressivity” or “tax progression,” affects how much you actually have left to spend after taxes: your remaining disposable income.

In our example, you have an annual salary of €49,000 gross. “Gross” in this case means before taxes and contributions are deducted from this amount, not the money you actually keep. Now they tell you that your salary is going to increase by 3%, that is to say, about €105 gross per month from now on, which you are happy about, only until you realize that at this moment you only receive about €54 net (that is to say , the amount you actually have left to use) more disposable income per month than before the increase. Why does this happen?

The answer: If you now earn more, your income may be subject to higher tax rates. Every time you receive a raise, your salary is usually subject to higher taxes than the previous one. But things are not that simple: for tax purposes, your salary is divided into different components. Each component of the total amount is subject to a different percentage of taxes.

Think of it this way: your salary is a pie that is cut into slices and each slice is subject to a different percentage. For example, the first “portion” between €11,000 and €18,000 could be subject to 20%, while the second “portion” between €18,000 and €31,000 is subject to 30%, and so on: the larger whatever the amount range, the higher the percentage.

In Spain, the tranches in 2021 are as follows: up to €12,450, 19%; from €12,450 to €20,200, 24%; from €20,200 to €35,200, 30%; from €35,200 to €60,000, 37%; from €60,000 to €300,000, 45% and from €300,000, 47%.

In other words, your income falls into several different brackets. That’s where the term “leg rise” comes from: the higher the leg, the more the percentage rises. Because of tax progression, your net income (after taxes) increases less than your gross income (before taxes), and that’s one of the reasons you feel like you’re left with so little to spend. The other reason is inflation.

Don’t forget inflation

The phenomenon of inflation modifies the relationship between money and goods or services. As inflation increases, more money is needed to obtain the same amount of a good or service.

As we have just verified, your net income grows more slowly than your gross salary due to the increase in the bracket. But if inflation rates are also on the rise, it means you can’t really afford to spend more than you did before your salary increase in the example. Your real purchasing power has not really improved despite your new salary. To reverse this situation, the tax brackets would have to be regularly adjusted upwards based on the evolution of inflation, something that does not usually happen.

Consequently, there is a difference between your nominal income (your income that has not been adjusted for the decrease in purchasing power) and your real income (your income taking into account the decrease in purchasing power).

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Why is nothing done about cold progressivity?

As low and medium incomes are mainly affected, which are obviously those obtained by the vast majority of the population of a country, governments receive significant amounts of funds thanks to cold progressivity, which they can use to finance measures that had previously been promised to voters at election time. Still, especially in those countries where tax rates are not adjusted for inflation rates, the question of whether governments should abolish cold progression remains hotly debated.

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