[How do I include inflation in my pay raise?]

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B4Xt3r
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[How do I include inflation in my pay raise?]

Post by B4Xt3r » Sun Sep 02, 2018 10:40 am

Hi All,

I am seeking a double check as to whether or not I am understanding the following correctly.
  • Let's assume that CPI-U is 2%
  • Let's assume that the total tax I pay on my next dollar is 35%
If my pay is to not take a real cut, then I need to receive a nominal raise of 2%/0.65 = 3.07%?

Thanks,

B4xt3r

tibbitts
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Re: Inflation, raises, and taxes.

Post by tibbitts » Sun Sep 02, 2018 10:48 am

B4Xt3r wrote:
Sun Sep 02, 2018 10:40 am
Hi All,

I am seeking a double check as to whether or not I am understanding the following correctly.
  • Let's assume that CPI-U is 2%
  • Let's assume that the total tax I pay on my next dollar is 35%
If my pay is to not take a real cut, then I need to receive a nominal raise of 2%/0.65 = 3.07%?

Thanks,

B4xt3r
That sounds approximately correct. Most people I know have seen inflation-adjusted wages decrease considerably for the past decade or so.

B4Xt3r
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Re: Inflation, raises, and taxes.

Post by B4Xt3r » Sun Sep 02, 2018 11:00 am

tibbitts wrote:
Sun Sep 02, 2018 10:48 am
That sounds approximately correct. Most people I know have seen inflation-adjusted wages decrease considerably for the past decade or so.
OK, thanks, I don't doubt it - I was surprised when I realized the above line of reasoning.

I'm curious how this is sustainable, then? Is everyone's quality of life decreasing per year?

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Re: Inflation, raises, and taxes.

Post by NightFall » Sun Sep 02, 2018 11:24 am

I disagree. If your marginal rate is X and your effective rate is Y, then you you need (1-Y) x 2% / (1-X) to maintain the same spending power. Your formula assumes that your effective rate is 0. In reality, things get even more complicated with the different deductions and such if they're not indexed to inflation, but this is at least a first order approximation.

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Re: Inflation, raises, and taxes.

Post by tibbitts » Sun Sep 02, 2018 11:25 am

B4Xt3r wrote:
Sun Sep 02, 2018 11:00 am
tibbitts wrote:
Sun Sep 02, 2018 10:48 am
That sounds approximately correct. Most people I know have seen inflation-adjusted wages decrease considerably for the past decade or so.
OK, thanks, I don't doubt it - I was surprised when I realized the above line of reasoning.

I'm curious how this is sustainable, then? Is everyone's quality of life decreasing per year?
Quality of life is more difficult to determine. As measured by real wages, yes most people I know have to spend a higher percentage of income on relatively non-discretionary expenditures - medical expenses, sales and property taxes, etc. - vs. a decade ago. The quality and utility of some items we spend money for may have increased, others may have decreased.

My personal observation was that the wages relative to more-or-less mandatory expenditures increased in a way during the 1980s and 1990s that they haven't so far during the 2000's. My guess is that many Bogleheads have had a different personal experience, but this group is somewhat self-selective. People who have had real wage decreases for a decade are less likely to be here discussing what to do with their excess income.

I don't see why the current situation wouldn't be sustainable indefinitely.

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Re: Inflation, raises, and taxes.

Post by tibbitts » Sun Sep 02, 2018 11:40 am

NightFall wrote:
Sun Sep 02, 2018 11:24 am
I disagree. If your marginal rate is X and your effective rate is Y, then you you need (1-Y) x 2% / (1-X) to maintain the same spending power. Your formula assumes that your effective rate is 0. In reality, things get even more complicated with the different deductions and such if they're not indexed to inflation, but this is at least a first order approximation.
Maybe an example would help. I think you're saying the structure of tax rates and deductions means you need a greater increase in wages to keep pace with inflation, but roughly it seems like the OP has the right idea.

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Re: Inflation, raises, and taxes.

Post by LadyGeek » Sun Sep 02, 2018 11:42 am

I removed an off-topic post (opinion of fed policy). As a reminder, see: Non-actionable (Trolling) Topics
If readers can't do anything with the content of a topic other than argue about it, it does not belong here. Examples include:
  • US or world economic, political, tax, health care and climate policies
  • conspiracy theories of any type
  • discussions of the crimes, shortcomings or stupidity of other people, whether they be political figures, celebrities, CEOs, Fed chairmen, subprime mortgage borrowers, lottery winners, federal "bailout" recipients, poor people, rich people, etc. Of course, you are welcome to talk about the stupid financial things you have done.
I also retitled the thread.

Please stay focused on helping the OP with the calculation.
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B4Xt3r
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Re: Inflation, raises, and taxes.

Post by B4Xt3r » Sun Sep 02, 2018 11:50 am

NightFall wrote:
Sun Sep 02, 2018 11:24 am
I disagree. If your marginal rate is X and your effective rate is Y, then you you need (1-Y) x 2% / (1-X) to maintain the same spending power. Your formula assumes that your effective rate is 0. In reality, things get even more complicated with the different deductions and such if they're not indexed to inflation, but this is at least a first order approximation.
Is this true? (I'm just trying to reason it out with you.)

Let's say I have 10k of expenses this year. Next year I will have $10.2k, which means I need an extra post-tax $200 on the margin to maintain my quality of life. In order to get that post-tax, marginal $200 - if I pay 35% total on the next dollars that I get, I will need an extra $308 pre-tax (since $108=.35*$308 will be paid to uncle Sam). It seems that my effective rate didn't need to come in to the math since what mattered was "on the margin."

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Re: Inflation, raises, and taxes.

Post by B4Xt3r » Sun Sep 02, 2018 11:54 am

tibbitts wrote:
Sun Sep 02, 2018 11:25 am
As measured by real wages, yes most people I know have to spend a higher percentage of income on relatively non-discretionary expenditures - medical expenses, sales and property taxes, etc. - vs. a decade ago.

...

I don't see why the current situation wouldn't be sustainable indefinitely.
How can it be sustainable when people are forced to spend an ever increasing amount of there income on basic necessities? If that is true, won't everyone be force to spend all there money on basic (food/shelter/clothing, etc.)

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Re: Inflation, raises, and taxes.

Post by B4Xt3r » Sun Sep 02, 2018 11:55 am

tibbitts wrote:
Sun Sep 02, 2018 11:40 am
NightFall wrote:
Sun Sep 02, 2018 11:24 am
I disagree. If your marginal rate is X and your effective rate is Y, then you you need (1-Y) x 2% / (1-X) to maintain the same spending power. Your formula assumes that your effective rate is 0. In reality, things get even more complicated with the different deductions and such if they're not indexed to inflation, but this is at least a first order approximation.
Maybe an example would help. I think you're saying the structure of tax rates and deductions means you need a greater increase in wages to keep pace with inflation, but roughly it seems like the OP has the right idea.
Is the example I provided above sound?

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Re: [How do I include inflation in my pay raise?]

Post by NightFall » Sun Sep 02, 2018 12:32 pm

No. Your raise is not measured in terms of your expenses. If you want to measure things in terms of your expenses, you should not measure raises as a percentage of salary. You can use your reasoning to figure out the absolute amount your salary should increase, but it should be less than the value you specified.

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Re: [How do I include inflation in my pay raise?]

Post by NightFall » Sun Sep 02, 2018 12:38 pm

Example, say your salary is $100,000. You take home $80,000 but your marginal rate is 35%. If inflation is 2%, you need $80,000 = $81,600 to maintain your same standard of living. You will need an absolute raise of $1,600/.65 = $2461. That is a raise of 2.46%, which is precisely the amount that I specified.

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Re: [How do I include inflation in my pay raise?]

Post by Nate79 » Sun Sep 02, 2018 12:48 pm

CPI-U doesn't represent your actual inflation rate. Best to look at your actual expenditures and estimate your actual inflation if possible.

B4Xt3r
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Re: [How do I include inflation in my pay raise?]

Post by B4Xt3r » Sun Sep 02, 2018 2:08 pm

NightFall wrote:
Sun Sep 02, 2018 12:38 pm
Example, say your salary is $100,000. You take home $80,000 but your marginal rate is 35%. If inflation is 2%, you need $80,000 = $81,600 to maintain your same standard of living. You will need an absolute raise of $1,600/.65 = $2461. That is a raise of 2.46%, which is precisely the amount that I specified.
Ok, I think that I stand corrected. Thank you. My mistake was not accounting for the fact that I live off post-tax dollars, and therefore my effective tax rate should be accounted for somewhere.

Let me restate as a check of my understanding. My take home pay is (salary)*(1-effective tax rate). The inflation induced increase in that amount is (inflation rate)*(salary)*(1-effective tax rate). The ability to obtain that inflation induced increase via a pay raise is (pay raise percent)*(salary)*(1-marginal tax rate). So equating the two, and solving for the pay raise percent is indeed (inflation rate)*(1-effective tax rate)/(1-marginal tax rate). Which is what you stated above using X and Y.

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Re: [How do I include inflation in my pay raise?]

Post by NightFall » Sun Sep 02, 2018 3:09 pm

You got it. You do bring up an interesting point that our progressive tax system does tend to require higher than inflation increases just to maintain the same standard of living. I hadn't thought about that before your post.

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Re: [How do I include inflation in my pay raise?]

Post by Svensk Anga » Sun Sep 02, 2018 3:25 pm

NightFall wrote:
Sun Sep 02, 2018 12:38 pm
Example, say your salary is $100,000. You take home $80,000 but your marginal rate is 35%. If inflation is 2%, you need $80,000 = $81,600 to maintain your same standard of living. You will need an absolute raise of $1,600/.65 = $2461. That is a raise of 2.46%, which is precisely the amount that I specified.
This is not quite right. Because most of the tax code is indexed for inflation, next year, even in the absence of any raise, the OP's take-home pay will go up. The Federal income tax owed will be lower due to higher standard deduction and more of the income being taxed in the inflated lower brackets.

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Re: [How do I include inflation in my pay raise?]

Post by B4Xt3r » Sun Sep 02, 2018 3:28 pm

NightFall wrote:
Sun Sep 02, 2018 3:09 pm
You got it. You do bring up an interesting point that our progressive tax system does tend to require higher than inflation increases just to maintain the same standard of living. I hadn't thought about that before your post.
Bold is mine. That is an interesting point, because if your effective rate equal to your marginal rate, then this effect goes away.

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Re: [How do I include inflation in my pay raise?]

Post by HJY700 » Sun Sep 02, 2018 5:02 pm

This thread is incredibly helpful and also totally nuts!

The latest CPI-U annual increase for the San Francisco region is 3.9%, according to BLS. Using my own (but probably not atypical) effective and marginal rates, I would need a 4.5% increase just to keep up with cost of living. The standard pay raise at my megacorp is not that high.

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Re: Inflation, raises, and taxes.

Post by tibbitts » Sun Sep 02, 2018 5:24 pm

B4Xt3r wrote:
Sun Sep 02, 2018 11:54 am
tibbitts wrote:
Sun Sep 02, 2018 11:25 am
As measured by real wages, yes most people I know have to spend a higher percentage of income on relatively non-discretionary expenditures - medical expenses, sales and property taxes, etc. - vs. a decade ago.

...

I don't see why the current situation wouldn't be sustainable indefinitely.
How can it be sustainable when people are forced to spend an ever increasing amount of there income on basic necessities? If that is true, won't everyone be force to spend all there money on basic (food/shelter/clothing, etc.)
Not everyone is not receiving any pay increases, and even for many of those who earn less in real terms every year, it may take a while before they spend all their money on "necessities." Also, the idea of necessities has evolved over time - generally some things that used to not be considered luxuries tend to become essentials over time. There's no rule that says the opposite can't occur.

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Re: [How do I include inflation in my pay raise?]

Post by B4Xt3r » Sun Sep 02, 2018 6:25 pm

HJY700 wrote:
Sun Sep 02, 2018 5:02 pm
This thread is incredibly helpful and also totally nuts!

The latest CPI-U annual increase for the San Francisco region is 3.9%, according to BLS. Using my own (but probably not atypical) effective and marginal rates, I would need a 4.5% increase just to keep up with cost of living. The standard pay raise at my megacorp is not that high.
Yeah. If that is true, I believe that you are getting a real (not nominal) pay cut. Sorry!

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Re: Inflation, raises, and taxes.

Post by B4Xt3r » Sun Sep 02, 2018 6:26 pm

tibbitts wrote:
Sun Sep 02, 2018 5:24 pm
B4Xt3r wrote:
Sun Sep 02, 2018 11:54 am
tibbitts wrote:
Sun Sep 02, 2018 11:25 am
As measured by real wages, yes most people I know have to spend a higher percentage of income on relatively non-discretionary expenditures - medical expenses, sales and property taxes, etc. - vs. a decade ago.

...

I don't see why the current situation wouldn't be sustainable indefinitely.
How can it be sustainable when people are forced to spend an ever increasing amount of there income on basic necessities? If that is true, won't everyone be force to spend all there money on basic (food/shelter/clothing, etc.)
Not everyone is not receiving any pay increases, and even for many of those who earn less in real terms every year, it may take a while before they spend all their money on "necessities." Also, the idea of necessities has evolved over time - generally some things that used to not be considered luxuries tend to become essentials over time. There's no rule that says the opposite can't occur.
I guess the future we are discussing isn't sustainable, but I don't see this subdiscussion as actionable so perhaps we should avoid delving further.

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Re: [How do I include inflation in my pay raise?]

Post by H-Town » Sun Sep 02, 2018 6:43 pm

B4Xt3r wrote:
Sun Sep 02, 2018 10:40 am
Hi All,

I am seeking a double check as to whether or not I am understanding the following correctly.
  • Let's assume that CPI-U is 2%
  • Let's assume that the total tax I pay on my next dollar is 35%
If my pay is to not take a real cut, then I need to receive a nominal raise of 2%/0.65 = 3.07%?

Thanks,

B4xt3r
Think of it as tax buckets: the first $20,800 you spend is tax free (standard deductions + exemptions for MFJ). The next $9,325 you spend was taxed at 10%, and so on... You get the idea. So the more you spend, the more expensive it gets. So, you might want to use effective tax rate rather than marginal tax rate in your calculation.

However, inflation is very personal. Inflation also has different affects for different products and services.

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Re: [How do I include inflation in my pay raise?]

Post by NightFall » Mon Sep 03, 2018 10:08 am

Svensk Anga wrote:
Sun Sep 02, 2018 3:25 pm
NightFall wrote:
Sun Sep 02, 2018 12:38 pm
Example, say your salary is $100,000. You take home $80,000 but your marginal rate is 35%. If inflation is 2%, you need $80,000 = $81,600 to maintain your same standard of living. You will need an absolute raise of $1,600/.65 = $2461. That is a raise of 2.46%, which is precisely the amount that I specified.
This is not quite right. Because most of the tax code is indexed for inflation, next year, even in the absence of any raise, the OP's take-home pay will go up. The Federal income tax owed will be lower due to higher standard deduction and more of the income being taxed in the inflated lower brackets.
That's a good point. As long as the brackets and deductions are all indexed to the same numbers, it's a wash.

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Re: [How do I include inflation in my pay raise?]

Post by grabiner » Mon Sep 03, 2018 10:46 am

B4Xt3r wrote:
Sun Sep 02, 2018 10:40 am
Hi All,

I am seeking a double check as to whether or not I am understanding the following correctly.
  • Let's assume that CPI-U is 2%
  • Let's assume that the total tax I pay on my next dollar is 35%
If my pay is to not take a real cut, then I need to receive a nominal raise of 2%/0.65 = 3.07%?
No, because tax brackets are indexed to inflation. If you get a 2% raise and the tax brackets increase by 2%, you will have a 2% increase in your tax and a 2% increase in your take-home pay, so you will keep your purchasing power.

(With the 2018 changes to the tax law, things will be very different; you may get much more or much less after tax depending on what types of income you have and what deductions you use.)
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Re: [How do I include inflation in my pay raise?]

Post by TD2626 » Mon Sep 03, 2018 11:52 am

Since the tax brackets are indexed to inflation, the amount in the highest bracket will not change if you get a raise equal to CPI. The lower bound for that bracket will go up as the tax brackets themselves are changed, and the higher bound will go up with the raise.

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Re: [How do I include inflation in my pay raise?]

Post by B4Xt3r » Mon Sep 03, 2018 5:36 pm

I'm a bit confused by the discussion of tax brackets. Can someone provide an example with numbers?

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Re: [How do I include inflation in my pay raise?]

Post by grabiner » Mon Sep 03, 2018 6:20 pm

B4Xt3r wrote:
Mon Sep 03, 2018 5:36 pm
I'm a bit confused by the discussion of tax brackets. Can someone provide an example with numbers?
I'll make up some numbers to make the math easier.

Suppose that the standard deduction is $20,000, and you then pay 10% tax on taxable income up to $10,000, and 15% tax on the amount from $10,000 to $70,000, and 25% tax on the amount over $70,000. If your income is $100,000, your taxable income is $80,000, and you will pay 10% tax on $10,000, and 15% tax on $60,000, and 25% tax on the last $10,000, for a total tax bill of $12,500. Your after-tax income is $87,500.

The next year, inflation is 5%, and you get a raise to $105,000. The new standard deduction is $21,000, and the 10% tax bracket applies to taxable income up to $10,500, and the 15% tax bracket applies to taxable income between $10,500 and $73,500, and the 25% tax bracket applies to the amount over $73,500. Your taxable income is $84,000, and you pay 10% tax on $10,500, and 15% tax on $63,000, and 25% tax on the last $10,500. You pay 5% more tax in each bracket, so your total tax bill increases by 5% to $13,125. Your after-tax income is $91,875, which is 5% higher than the previous year.
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Re: [How do I include inflation in my pay raise?]

Post by phantom0308 » Mon Sep 03, 2018 8:14 pm

Also 401k max contributions are indexed to inflation so you could theoretically bump income from inflation into lower tax brackets.

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Re: [How do I include inflation in my pay raise?]

Post by B4Xt3r » Tue Sep 04, 2018 6:42 am

grabiner wrote:
Mon Sep 03, 2018 6:20 pm
B4Xt3r wrote:
Mon Sep 03, 2018 5:36 pm
I'm a bit confused by the discussion of tax brackets. Can someone provide an example with numbers?
I'll make up some numbers to make the math easier.

Suppose that the standard deduction is $20,000, and you then pay 10% tax on taxable income up to $10,000, and 15% tax on the amount from $10,000 to $70,000, and 25% tax on the amount over $70,000. If your income is $100,000, your taxable income is $80,000, and you will pay 10% tax on $10,000, and 15% tax on $60,000, and 25% tax on the last $10,000, for a total tax bill of $12,500. Your after-tax income is $87,500.

The next year, inflation is 5%, and you get a raise to $105,000. The new standard deduction is $21,000, and the 10% tax bracket applies to taxable income up to $10,500, and the 15% tax bracket applies to taxable income between $10,500 and $73,500, and the 25% tax bracket applies to the amount over $73,500. Your taxable income is $84,000, and you pay 10% tax on $10,500, and 15% tax on $63,000, and 25% tax on the last $10,500. You pay 5% more tax in each bracket, so your total tax bill increases by 5% to $13,125. Your after-tax income is $91,875, which is 5% higher than the previous year.
OK. I think I understand the math that you did now. Doesn't this directly contradict the conclusion made above that the raise depends on the both the marginal and effective tax rates? If so, our mistake was assuming that the marginal and effective tax rates were independent of inflation, which is not true since the brackets themselves are indexed to inflation.

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Re: [How do I include inflation in my pay raise?]

Post by Katietsu » Tue Sep 04, 2018 7:06 am

B4Xt3r wrote:
Tue Sep 04, 2018 6:42 am
grabiner wrote:
Mon Sep 03, 2018 6:20 pm
B4Xt3r wrote:
Mon Sep 03, 2018 5:36 pm
I'm a bit confused by the discussion of tax brackets. Can someone provide an example with numbers?
I'll make up some numbers to make the math easier.

Suppose that the standard deduction is $20,000, and you then pay 10% tax on taxable income up to $10,000, and 15% tax on the amount from $10,000 to $70,000, and 25% tax on the amount over $70,000. If your income is $100,000, your taxable income is $80,000, and you will pay 10% tax on $10,000, and 15% tax on $60,000, and 25% tax on the last $10,000, for a total tax bill of $12,500. Your after-tax income is $87,500.

The next year, inflation is 5%, and you get a raise to $105,000. The new standard deduction is $21,000, and the 10% tax bracket applies to taxable income up to $10,500, and the 15% tax bracket applies to taxable income between $10,500 and $73,500, and the 25% tax bracket applies to the amount over $73,500. Your taxable income is $84,000, and you pay 10% tax on $10,500, and 15% tax on $63,000, and 25% tax on the last $10,500. You pay 5% more tax in each bracket, so your total tax bill increases by 5% to $13,125. Your after-tax income is $91,875, which is 5% higher than the previous year.
OK. I think I understand the math that you did now. Doesn't this directly contradict the conclusion made above that the raise depends on the both the marginal and effective tax rates? If so, our mistake was assuming that the marginal and effective tax rates were independent of inflation, which is not true since the brackets themselves are indexed to inflation.
Yes, that was the mistake.

(In reality, it might not be that simple for everyone because some parts of the tax code are more indexed for inflation such as the NIIT tax or the taxable social security calculations.)

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