Progressive Income Taxation and Inflation: The Macroeconomic Effects of Bracket Creep

Lukas Hack

VfS Annual Conference 2024 (Berlin): Upcoming Labor Market Challenges from Verein für Socialpolitik / German Economic Association

Abstract: Under nominal progressive taxation, inflation drives up tax rates if the schedule is not adjusted, leading to bracket creep. To isolate bracket creep from other sources of tax rate changes, I propose a non-parametric decomposition of changes in tax rates. Applying the decomposition to German administrative tax records, I find sizeable bracket creep episodes. While the overall importance of bracket creep has decreased over time due to institutional changes, the post-Covid inflation surge led to a resurgence. I characterize how bracket creep affects labor supply decisions in a partial equilibrium framework. Further, I estimate a theory-consistent measure of bracket creep, the indexation gap, which is used to discipline a New Keynesian model with incomplete markets. The model predicts that a given reduction in inflation via a monetary contraction leads to less output costs in an economy with bracket creep.

JEL-codes: E31 E62 H24 (search for similar items in EconPapers)
Date: 2024
New Economics Papers: this item is included in nep-dge and nep-pbe
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