Falling Up The Stairs: The Effects Of “Bracket Creep” On Household Incomes

This paper analyzes how inflation‐induced erosions of nominally defined amounts built into relevant tax rules (“bracket creep”) alter distributional and revenue‐generating properties of income taxes and social insurance contributions. Using a multi‐country tax‐benefit model, it provides quantitative estimates for Germany, the Netherlands and the U.K. In the absence of automatic inflation adjustment mechanisms, effects on individual tax burdens can be substantial, even with low inflation. Bracket creep is found to reduce tax progressivity. At the same time, overall tax revenues increase. In terms of tax systems’ equalizing capacities, which depend on both these factors, the second effect dominates: if tax systems were left unadjusted then inflation would lead to lower and slightly more equally distributed household incomes. However, existing inflation adjustment regimes in the Netherlands and the U.K. successfully prevent large tax burdens changes.