Real income is the income purchasing power of an individual, group, or nation adjusted for changes in prices. If an individual’s income rises faster than inflation, his or her real income has increased. Often the opposite occurs, and people’s incomes rise at less than the rate of inflation. Frequently in the United States, workers and unions representing workers begin wage negotiations by asking for a wage increase equal to the inflation rate of the previous year. Pensions and Social Security payments include COLAs (cost-of-living adjustments) designed to allow recipients to maintain their level of real income. Many U.S. agricultural support programs were initiated with the goal of increasing farm incomes equal to the increase in nonfarm incomes, thereby encouraging workers to remain in agriculture.
While support programs and COLAs can increase people’s real incomes, it often results in “bracket creep,” the movement into higher marginal tax brackets. The U.S. personal income-tax system is a progressive tax system; as nominal income increases, tax rates increase. Increased income to offset inflation may push individuals’ taxable incomes into higher brackets, reducing their real and disposable incomes. Similarly, tax cuts without an increase in inflation increases people’s real incomes.