TY  - CHAP
AB  - By reducing the real value of nominally fixed tax band limits, deductions and tax credits, inflation can lead to higher real tax burdens (“fiscal drag”). The traditional view is that this reduces aggregate demand and thus acts as an automatic stabiliser. Yet, this familiar reasoning ignores the supply side and, in particular, possible effects of higher tax burdens on labour costs. Recent work on imperfect labour markets has shown that such effects can indeed arise as employees are able to bargain for higher wages that partly compensate for tax increases. In this case, the resulting upwards pressure on real labour costs can be inflationary. To illustrate this mechanism, this article analyses labour tax burdens in four European countries and how they are altered if tax systems are not adjusted for inflation. This is then combined with available results on the effects of tax changes on wages in imperfect labour markets. The results suggest that, in an unadjusted tax system, inflation can produce a moderate upward pressure on wages. It is argued, however, that more detailed empirical work on the role of taxes in the wage-setting process is needed as existing work ignores the substantial heterogeneity of workers and the tax rates they face.
VL  - 25
SN  - 978-1-84950-442-3, 978-0-76231-347-1/0147-9121
DO  - 10.1016/S0147-9121(06)25006-4
UR  - https://doi.org/10.1016/S0147-9121(06)25006-4
AU  - Immervoll Herwig
ED  - Olivier Bargain
PY  - 2006
Y1  - 2006/01/01
TI  - Fiscal Drag – An Automatic Stabiliser?
T2  - Micro-Simulation in Action
T3  - Research in Labor Economics
PB  - Emerald Group Publishing Limited
SP  - 141
EP  - 163
Y2  - 2024/04/20
ER  -