Question

Due to inflation, an increase in nominal wages will cause...

1) The real incomes to rise
2) The average rates of personal income tax to decrease
3) The average rates of personal income tax to increase
4) No change in the average rates of personal income tax

Answer 1

Correct option: The average rates of personal income tax to increase

When nominal income increases, personal income tax also increases. Therefore, when nominal wages will increase, then average rates of personal income tax will increase. Due to inflation, the real income of people will go down which eventually make them worse off but the personal income tax is based on the nominal wages and not on real wages. Therefore, average rates of personal income tax will increase only.