Fiscal drag in Greece

This paper uses a microsimulation approach to analyse the phenomenon of “fiscal drag†in Greece, i.e. the increase in tax revenues that arises when nominal tax bases grow, while the parameters of the personal income tax (PIT) system remain unchanged in nominal terms. First, we estimate the phenomenon in terms of the tax-to-base elasticity, which captures the responsiveness of PIT revenue to changes in the tax base under an unchanged legislation. The results suggest an elasticity of almost 1.8 in 2019, implying a built-in progressivity in the PIT system and, therefore, potential for fiscal drag. We further decompose this elasticity to identify its main drivers across income sources (labour, capital, self-employment, pensions and benefits) and tax parameters (tax brackets, tax deductions/credits) as well as across the income distribution. Second, we assess fiscal drag in practice between 2019 and 2023 by comparing actual PIT revenues (incorporating observed income growth and legislative changes) against counterfactual 2023 scenarios simulating alternative indexation practices. We quantify the actual impact of fiscal drag, defined as a share of GDP, and the extent to which government policies have managed to offset it. The findings indicate that, although Greece has no formal indexation of tax parameters, the tax policy reforms implemented between 2019 and 2023 more than offset the potential effects of fiscal drag, keeping PIT revenues broadly stable as a share of GDP, while slightly reducing the average effective tax rate. Overall, the results highlight that, during a period of rapid nominal income growth, Greece’s PIT reforms improved both the progressivity and the redistributive capacity of the tax system, while safeguarding PIT revenue. These insights are relevant for the design of future tax policy interventions.