The Central Bank of Latvia released a working paper that characterises “fiscal drag” across 21 European countries using a microsimulation approach, focusing on how progressive personal income tax systems can raise tax revenues when nominal incomes grow but tax parameters are not updated. The paper estimates tax-to-base elasticities and finds that built-in progressivity often implies elasticities around 1.7–2, suggesting scope for sizeable fiscal drag, while highlighting heterogeneity in drivers (tax brackets versus deductions and credits), across income sources (labour, capital, self-employment and public benefits) and across the income distribution. It also analyses fiscal drag in practice over 2019–2023 by incorporating observed income growth and legislative changes, quantifying both the realised impact and the extent to which governments offset it through indexation or other reforms.
Central Bank of Latvia 2025-10-14
Central Bank of Latvia publishes working paper measuring fiscal drag and its distributional effects across 21 European countries
The Central Bank of Latvia published a working paper analyzing "fiscal drag" in 21 European countries, using a microsimulation approach to assess the impact of progressive personal income tax systems on tax revenues. The study finds tax-to-base elasticities around 1.7–2, indicating significant fiscal drag potential, with variations across income sources and distribution. It evaluates fiscal drag from 2019–2023, considering income growth and legislative changes, and the extent of government offset through indexation or reforms.