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After the Death of Inflation: Will Fiscal Drag Survive?

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  • Heinemann, Friedrich

Abstract

Declining inflation rates might have negative consequences for tax revenues. Phenomena like the inflationary bracket creep in a progressive income tax system do not work any longer. With this background the paper analyzes the extent of fiscal drag for OECD countries since 1965. Some considerations on the role of money illusion and indexation in this context lay the theoretical base followed by a descriptive view on the relation between inflation, growth and tax revenues in the past decades. A framework is presented that allows for the classification of fiscal structures with regard to the type of fiscal drag. The subsequent econometric analysis is performed for total and disaggregated government revenues. The results reveal that an end of inflation would have a negative impact on tax revenues for a number of OECD countries. The results also back theoretical considerations on inflation?s impact on different kinds of taxes: This impact tends to be positive for individual income taxes and social security contributions, it is neutral or negative for corporate income, property and indirect taxation. The paper concludes that both declining inflation and recent trends in tax reforms can be expected to limit the potential for future fiscal drag.

Suggested Citation

  • Heinemann, Friedrich, 2000. "After the Death of Inflation: Will Fiscal Drag Survive?," ZEW Discussion Papers 00-19, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  • Handle: RePEc:zbw:zewdip:5304
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    References listed on IDEAS

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    1. Daniel Gros & Guyvandille, 1995. "Seigniorage and EMU: The Fiscal Implications of Price Stability and Financial Market Integration," Journal of Common Market Studies, Wiley Blackwell, vol. 33(2), pages 175-196, June.
    2. Alberto Alesina & Roberto Perotti, 1995. "Fiscal Expansions and Fiscal Adjustments in OECD Countries," NBER Working Papers 5214, National Bureau of Economic Research, Inc.
    3. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    4. W. STEYN & F.C.v.N. FOURIE, 1996. "The Structure of Personal Income Tax in Times of Inflation: A Formula Tax," South African Journal of Economics, Economic Society of South Africa, vol. 64(4), pages 200-208, December.
    5. Günther G. Schulze & Heinrich W. Ursprung, 1999. "Globalisation of the Economy and the Nation State," The World Economy, Wiley Blackwell, vol. 22(3), pages 295-352, May.
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    Cited by:

    1. Creedy, John & Gemmell, Norman, 2008. "Corporation tax buoyancy and revenue elasticity in the UK," Economic Modelling, Elsevier, vol. 25(1), pages 24-37, January.
    2. Sanz Labrador, Ismael & Sanz-Sanz, José Félix, 2013. "Política fiscal y crecimiento económico: consideraciones microeconómicas y relaciones macroeconómicas," Macroeconomía del Desarrollo 134, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
    3. Hechtner, Frank & Massarrat-Mashhadi, Nima & Sielaff, Christian, 2012. "Eine Analyse zur Einkommensteuerbelastung und Wirkung der kalten Progression der vergangenen 20 Jahre in Deutschland," arqus Discussion Papers in Quantitative Tax Research 137, arqus - Arbeitskreis Quantitative Steuerlehre.
    4. John Creedy & Norman Gemmell, 2010. "Modelling Corporation Tax Revenue," Books, Edward Elgar Publishing, number 13695.
    5. David Fielding, 2011. "New Zealand: The Last Bastion of Textbook Open-Economy Macroeconomics," Working Papers 1105, University of Otago, Department of Economics, revised Jun 2011.
    6. John Creedy & José Félix Sanz?Sanz, 2010. "Modelling Personal Income Taxation in Spain:Revenue Elasticities and Regional Comparisons," Department of Economics - Working Papers Series 1097, The University of Melbourne.
    7. Westerheide, Peter, 2006. "Nachgelagerte Besteuerung privater Altersvorsorgeaufwendungen: Auswirkungen auf die Alterseinkommen ausgewählter Haushaltstypen," ZEW Discussion Papers 06-090, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    8. Süssmuth, Bernd & Wieschemeyer, Matthias, 2017. "Progressive tax-like effects of inflation: Fact or myth? The U.S. post-war experience," IWH Discussion Papers 33/2017, Halle Institute for Economic Research (IWH).
    9. Altemeyer-Bartscher, Martin & Zeddies, Götz, 2017. "Bracket creeps: Bane or boon for the stability of numerical budget rules?," IWH Discussion Papers 29/2016, Halle Institute for Economic Research (IWH).

    More about this item

    Keywords

    bracket creep; fiscal drag; indexation; inflation; money illusion; Olivera-Tanzi effect; taxes; Wagner?s law;

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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