Unveiling the bracket creep: static versus dynamic fiscal drag

Abstract

This paper develops a simple model that accurately quantifies the surtax of not indexing the personal income tax schedule(s) in inflationary scenarios and the corrective compensation in case of total or partial indexing. The model is developed for the individual taxpayer and the population aggregate and identifies two different components within the bracket creep, one static, linked to the pre-inflation taxable income, and the other dynamic, associated with changes in the taxable income. Finally, an empirical application of the model to the case of Spain for 2022 is provided. The findings from this empirical analysis demonstrate that the decision not to index the tax schedule will impose an additional tax of over 1,187 million euros on Spanish taxpayers, of which 94% (1,114 million) corresponds to static bracket creep and the remainder (74 million) to the dynamic component. Paradoxically, although the static component is significantly larger, bracket creep continues to be defined in the literature in terms of its dynamic component.