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Fiscal drag in theory and practice: a European perspective

Author

Listed:
  • Esteban García-Mirallas

    (Banco de España)

  • Maximilian Freier

    (European Central Bank)

  • Sara Riscao

    (Organisation for Economic Co-operation and Development (OECD))

  • Chrysa Leventi

    (European Commission, Joint Research Centre)

  • Alberto Mazzon

    (European Commission, Joint Research Centre)

  • Glenn Abela

    (Central Bank of Malta)

  • Laura Boyd

    (Central Bank of Ireland)

  • Baiba Brusbārde

    (Latvijas Banka)

  • Marion Cochard

    (Banque de France)

  • David Cornille

    (National Bank of Belgium)

  • Emanuele Dicarlo

    (Banca d’Italia)

  • Ian Debattista

    (Central Bank of Malta)

  • Mar Delgado-Téllez

    (Banco de España)

  • 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 Jászberényi-Király

    (Magyar Nemzeti Bank)

  • Max Lay

    (ifo Institute)

  • Laura Lehtonen

    (De Nederlandsche Bank)

  • Mauro Mastrogiacomo

    (De Nederlandsche Bank)

  • Tara McIndoe-Calder

    (Central Bank of Ireland)

  • Mathias Moser

    (Oesterreichische Nationalbank (OeNB))

  • Martin Nevicky

    (National Bank of Slovakia)

  • Andreas Peichl

    (ifo Institute)

  • Myroslav Pidkuyko

    (Banco de España)

  • Mojca Roter

    (Banka Slovenije)

  • Frédérique Savignac

    (Banque de France)

  • Andreja Strojan Kastelec

    (Banka Slovenije)

  • Vaidotas Tuzikas

    (Lietuvos bankas)

  • Nikos Ventouris

    (Bank of Greece)

  • Lara Wemans

    (Banco de Portugal)

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 microsimu-lation 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 elastici-ties 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.

Suggested Citation

  • Esteban García-Mirallas & Maximilian Freier & Sara Riscao & Chrysa Leventi & Alberto Mazzon & Glenn Abela & Laura Boyd & Baiba Brusbārde & Marion Cochard & David Cornille & Emanuele Dicarlo & Ian Deba, 2025. "Fiscal drag in theory and practice: a European perspective," Working Paper Research 483, National Bank of Belgium.
    • Handle: RePEc:nbb:reswpp:202510-483
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    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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