| Fiscal Drag |
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EXAMPLE OF FISCAL DRAG
BRACKET CREEP Bracket creep describes the process by which Inflation pushes wages and salaries into higher Tax Bracket s. Many Progressive Tax Systems are not adjusted for inflation. As wages and salaries rise in nominal terms under the influence of inflation they become more highly taxed, even though in real terms the value of the wages and salaries has not increased at all. The net effect is that in real terms taxes rise unless the tax rates or brackets are adjusted to compensate. REAL FISCAL DRAG Real fiscal drag takes place when tax thresholds are increased in line with price rises, but where a growing economy means that earnings rise faster still, so increasing taxes as proportion of earnings. POLITICAL DIMENSION Though (nominal) fiscal drag can easily be countered by a system of Index-linked Tax Brackets , this may be politically undesirable. Many voters do not perceive the effects of fiscal drag, and so the government may prefer to adjust tax brackets manually once every few years - in effect restoring the real tax rates to their pre-inflation levels, but in a way that makes the government seem like they are giving the taxpayer an additional benefit. Ireland is an example of a country in which, in recent years, the progressive income tax system has allowed government revenues to swell due to fiscal drag (both nominal and real) without either increases in the tax rates or decreases in the thresholds. This is because the country has experienced considerable economic growth under the low-interest monetary regime of the European Central Bank , resulting in high wage inflation. |
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