Fiscal Drag in Theory and in Practice: a European Perspective

Esteban Garcia-Miralles, Maximilian Freier, Sara Riscado, Chrysa Leventi, Alberto Mazzon, Glenn Abela, Laura Boyd, Baiba Brusbarde, Marion Cochard, David Cornille, Emanuele Dicarlo (), Ian Debattista, Mar Delgado-Tellez, Mathias Dolls, Ludmila Fadejeva, Maria Flevotomou, Florian Henne, Alena Harrer-Bachleitner, Viktor Jaszberenyi-Kiraly, Max Lay, Laura Lehtonen, Mauro Mastrogiacomo, Tara McIndoe-Calder, Mathias Moser, Martin Nevicky, Andreas Peichl, Myroslav Pidkuyko, Mojca Roter, Frederique Savignac, Andreja Strojan Kastelec, Vaidotas Tuzikas, Nikos Ventouris and Lara Wemans
Additional contact information
Maximilian Freier: European Central Bank
Sara Riscado: OECD
Chrysa Leventi: European Commission
Alberto Mazzon: European Commission
Glenn Abela: Central Bank of Malta
Laura Boyd: Central Bank of Ireland
Baiba Brusbarde: Latvijas Banka
Marion Cochard: Banque de France
David Cornille: National Bank of Belgium
Ian Debattista: 5Central Bank of Malta
Mar Delgado-Tellez: Banco de Espana
Mathias Dolls: ifo Institute
Ludmila Fadejeva: Latvijas Banka
Maria Flevotomou: Bank of Greece
Florian Henne: Banque centrale du Luxembourg
Alena Harrer-Bachleitner: Office of the Austrian Fiscal Council
Viktor Jaszberenyi-Kiraly: Magyar Nemzeti Bank
Laura Lehtonen: De Nederlandsche Bank
Mauro Mastrogiacomo: De Nederlandsche Bank
Tara McIndoe-Calder: Central Bank of Ireland
Mathias Moser: Oesterreichische Nationalbank
Martin Nevicky: National Bank of Slovakia
Andreas Peichl: ifo Institute
Myroslav Pidkuyko: Banco de Espana
Mojca Roter: Banka Slovenije
Frederique Savignac: Banque de France
Andreja Strojan Kastelec: Banka Slovenije
Vaidotas Tuzikas: Lietuvos bankas
Nikos Ventouris: Bank of Greece
Lara Wemans: Banco de Portugal

No 2025/07, Working Papers from Latvijas Banka

Abstract: This paper presents a comprehensive characterization of "fiscal drag" - the increase in tax revenue that occurs when nominal tax bases grow but nominal parameters of progressive tax legislation are not updated accordingly - across 21 European countries using a microsimulation approach. First, we estimate tax-to-base elasticities, showing that the progressivity built in each country's personal income tax system induces elasticities around 1.7-2 for many countries, indicating a potential for large fiscal drag effects. We unpack these elasticities to show stark heterogeneity in their underlying mechanisms (tax brackets or tax deductions and credits), across income sources (labor, capital, self-employment, public benefits), and across the individual income distribution. Second, we extend the analysis beyond these elasticities to study fiscal drag in practice between 2019 and 2023, incorporating observed income growth and legislative changes. We quantify the actual impact of fiscal drag and the extent to which government policies have offset it, either through indexation or other reforms. Our results provide new insights into the fiscal and distributional effects of fiscal drag in Europe, as well as useful statistics for modeling public finances.

Keywords: personal income tax; inflation; indexation; bracket creep (search for similar items in EconPapers)
JEL-codes: D31 E62 H24 (search for similar items in EconPapers)
Date: 2025-10-14
New Economics Papers: this item is included in nep-eec and nep-mac
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https://datnes.latvijasbanka.lv/papers/WP_7_2025.pdf (application/pdf)

Related works:
Working Paper: Fiscal Drag in Theory and in Practice: A European Perspective (2025)
Working Paper: Fiscal Drag in Theory and in Practice: a European Perspective (2025)
Working Paper: Fiscal drag in theory and in practice: a European perspective (2025)
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Persistent link: https://EconPapers.repec.org/RePEc:ltv:wpaper:202507

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