Fiscal drag happens when the government's net
fiscal position (spending minus taxation) fails to cover the net savings desires of the private economy, also called the private economy's spending gap (earnings minus spending and private investment). The resulting lack of
aggregate demand
In economics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the ...
leads to
deflationary pressure, or drag, on the economy, essentially due to lack of state spending or to excess taxation.
One cause of fiscal drag may be
bracket creep
Bracket creep is usually defined as the process by which inflation pushes wages and salaries into higher tax brackets, leading to fiscal drag. However, even if there is only one tax bracket, or one remains within the same tax bracket, there wil ...
, where
progressive taxation increases automatically as taxpayers move into higher tax brackets due to
inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
. This tends to moderate inflation, and can be characterized as an automatic stabilizer to the economy. Fiscal drag can also be a result of a hawkish stance towards government finances.
Real fiscal drag
Real fiscal drag takes place when tax thresholds are increased in line with price rises to avoid ''nominal fiscal drag'', but where a growing economy means that earnings rise faster still, so increasing taxes as proportion of earnings.
Political dimension
Ireland
Ireland (, ; ; Ulster Scots dialect, Ulster-Scots: ) is an island in the North Atlantic Ocean, in Northwestern Europe. Geopolitically, the island is divided between the Republic of Ireland (officially Names of the Irish state, named Irelan ...
is an example of a country in which, in recent years,{{when?, date=April 2019 the
progressive income tax system has allowed government revenues to swell due to both nominal and real fiscal drag without either increases in the tax rates or decreases in the thresholds. That is because the country has experienced considerable economic growth, which some attribute to the low-interest monetary regime of the
European Central Bank
The European Central Bank (ECB) is the central component of the Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's Big Four (banking)#International ...
, resulting in high
wage inflation. Whereas others attribute to the economic and educational policies of the Irish government, in subsidizing education and eliminating taxation of the arts, two historically low-income demographics that would thus respond strongly to an increase in income, resulting in
price inflation and thus
wage inflation to retain
purchasing power parity
Purchasing power parity (PPP) is a measure of the price of specific goods in different countries and is used to compare the absolute purchasing power of the countries' currency, currencies. PPP is effectively the ratio of the price of a market bask ...
.
See also
*
Fiscal deficit
The government budget balance, also referred to as the general government balance, public budget balance, or public fiscal balance, is the difference between government revenues and spending. For a government that uses accrual accounting ( ...
*
Bracket Creep
Bracket creep is usually defined as the process by which inflation pushes wages and salaries into higher tax brackets, leading to fiscal drag. However, even if there is only one tax bracket, or one remains within the same tax bracket, there wil ...
References
The Economist Economics A-Z: Fiscal drag ttp://www.oecd.org/document/57/0,3343,en_2649_34533_40233913_1_1_1_1,00.html Taxing Wages 2006/2007: 2007 Edition OECD
The Organisation for Economic Co-operation and Development (OECD; , OCDE) is an international organization, intergovernmental organization with 38 member countries, founded in 1961 to stimulate economic progress and international trade, wor ...
.
Fiscal Drag - An Automatic Stabiliser? b
After the Death of Inflation: Will Fiscal Drag Survive? by Friedrich Heinemann
Tax bands, a chancellor's best friends BBC News
Fiscal policy