The European Central Bank published a working paper assessing “fiscal drag” (bracket creep) in personal income tax systems across 21 European countries (all euro area members and Hungary) using microsimulation. It finds substantial built-in sensitivity of tax revenues to nominal income growth and wide cross-country differences in how far policy changes offset fiscal drag between 2019 and 2023. Estimating tax-to-base elasticities under unchanged tax rules, the authors report values around 1.7–2 for many countries, implying that a 1% increase in the tax base would raise personal income tax revenue by close to 2% absent parameter updates. The paper attributes fiscal drag mechanisms to both bracket progressivity and the design of deductions and credits (with roughly similar average contributions), and shows stronger effects for labour income than for pensions or capital income, with larger elasticities for low- and middle-income groups than for top earners. Comparing 2023 outcomes with counterfactual scenarios of full indexation versus no indexation since 2019, it concludes that all countries dampened fiscal drag to some extent, but about one-third offset it only partially, associated with noticeable increases in effective tax rates (around 1 percentage point) and revenue (around 0.5% of GDP), while others largely neutralised it and some more than compensated it; a significant share of offsetting came via non-indexation reforms such as new deductions or tax rate changes rather than updating nominal parameters.
European Central Bank 2025-10-09
European Central Bank working paper quantifies fiscal drag across euro area countries and Hungary and finds uneven offsetting in 2019–2023
The European Central Bank's working paper examines "fiscal drag" in personal income tax systems across 21 European countries, highlighting significant sensitivity of tax revenues to nominal income growth and varying policy responses between 2019 and 2023. The study finds tax-to-base elasticities around 1.7–2, with stronger effects on labour income and larger impacts on low- and middle-income groups. It concludes that while all countries mitigated fiscal drag to some extent, about one-third only partially offset it, leading to increased effective tax rates and revenues, with many relying on non-indexation reforms.