Fiscal Drag in Theory and in Practice: a European Perspective

Working paper 844
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Published: 03 October 2025

By: Esteban García-Miralles Maximilian Freier Sara Riscado Chrysa Leventi Alberto Mazzon Glenn Abela Laura Lehtonen Laura Boyd Baiba Brusbārde Marion Cochard David Cornille Emanuele Dicarlo Ian Debattista Mar Delgado-Téllez Mathias Dolls Ludmila Fadejeva Maria Flevotomou Florian Henne Alena Harrer-Bachleitner Viktor Jaszberenyi-Kiraly Max Lay Mauro Mastrogiacomo Tara McIndoe-Calder Mathias Moser Martin Nevicky Andreas Peichl Myroslav Pidkuyko Mojca Roter Frédérique Savignac Andreja Strojan Kastelec Vaidotas Tuzikas Nikos Ventouris Lara Wemans

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 elas- ticities around 1.7–1.9 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 distribu- tion. 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 govern- ment 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;
JEL codes D31; H24; E62;

Working paper no. 844

844 - Fiscal Drag in Theory and in Practice: a European Perspective

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Research highlights:

  •         Fiscal drag can have potentially large impacts across most European countries, and these have materialized very unevenly during the recent inflationary period. This makes it difficult to properly assess the pass through of monetary policy to households.  

  • The elasticity of personal income tax revenue to the tax base is larger than 1 in most countries (2.1 in the Netherlands). This means that the progressivity of tax systems can generate sizeable fiscal drag if nominal parameters (thresholds, deductions, etc.) are not updated in line with income growth.

  • Given these elasticities and the policy choices made during 2019–2023, fiscal drag led to significantly higher revenues in one-third of countries, was approximately offset in another third, and overcompensated in the rest.

  • A large part of fiscal drag has been offset through reforms not linked to systematic indexation, and in their absence, fiscal drag would have been much more prevalent. Our findings underly the importance of tracking fiscal drag, understanding its impacts, and clarifying indexation practices.

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