Series: Occasional Papers. 2422.
Author: Sofía Balladares and Esteban García-Miralles.
Topics: Inequality | Household finances | Fiscal policy | International cooperation | Wages.
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Abstract
In recent years, personal income tax collection has shown strong dynamism. Part of this increase is due to household income growth, while another part is due to the “fiscal drag” effect, which results in an increase in average effective rates when the parameters that determine the tax (brackets and tax benefits) are not fully updated with inflation. This paper uses a tax microsimulation tool based on tax filers’ administrative data to study the magnitude of the fiscal drag effect, its heterogeneity across the income distribution, its mechanisms and its impact on tax collection and on average effective tax rates in recent years and in the future. It is estimated that, in the absence of indexation of the nominally defined parameters of the tax, a homogeneous increase in household income of 1% would lead to an increase in income tax revenue of 1.85%, in line with the average elasticity estimated for OECD countries. This effect is greater for middle and upper-middle incomes and produces an increase in effective tax rates across the entire distribution of tax filers, leading to a reduction in net income inequality. It is estimated that around half of the increase in the personal income tax-to-GDP ratio observed between 2019 and 2023 can be explained by the fiscal drag effect. Going forward, in the absence of changes in tax parameters, the ratio of personal income tax revenue to GDP could reach 9% in 2025, 29% higher than its level in 2019.