Inflation and Tax Reforms: A Study in Individual Taxation

Inflation affects real income tax liabilities in two ways. First, it erodes the real values of fixed deductions. Second, it moves a tax payer in a high tax bracket. Due to high rate of progressivity in taxes at lower end of the tax schedule, low income groups suffers more than high income groups during inflation. Ad hoc changes do not consider inflation effect explicitly, and thus, increase inequities in tax system, hurting some while helping others, in a socially undesirable way. May be we need to consider a planned indexed tax system to provide a much needed rationality and equity to the system. To reduce complexity, such indexation can be done every three or five years, provided that inflation remains moderate.