The term cold progression is used to refer to increases in tax burdens which are based on increases in income but do not account for inflation.
For example, incomes may be adjusted to compensate for rising living costs caused by inflation. When progressive taxation brackets are not adjusted to account for inflation, increases in taxpayers’ incomes can result in their being bumped into higher tax brackets and being taxed at higher tax rates without earning more in terms of actual purchasing power. In this case, actual income after adjustment for inflation may be lower than actual income before the income adjustment for inflation.
Example of cold progression:
A person has a taxable income of 50,000 Swiss francs which is taxed at a 10% tax rate, meaning they must pay 5000 francs income tax on their taxable income. That leaves the person with 45,000 francs or 90% of their pre-tax taxable income.
Inflation causes the costs of goods and services to increase by 6%, and the person’s salary is raised by 6% to compensate for the increased cost of living. Although their real wage has not increased, the person now has a higher taxable income of 53,000 francs and is bumped up into a higher tax bracket. They are now taxed at a 15% tax rate instead of the 10% tax rate applicable to their former taxable income. As a result, they pay 7950 francs in taxes, leaving them with just 85% of their pre-tax taxable income or 45,050 francs which after inflation has the purchasing power of just 42,500 francs compare to their former income.
More on this topic:
Progressive taxation explained
Marginal tax rates explained
Swiss federal income tax calculator
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