When incomes rise due to inflation but the tax scale remains unchanged, people automatically move to higher tax rates and pay more taxes without actually having more purchasing power. This phenomenon, known as tax erosion (fiscal drag), particularly burdens low and middle incomes and hurts tax fairness.

The Bank of Greece (BoG), in a special study for the period 2019-2023, explains that the tax burden increased implicitly, not because tax laws changed, but because incomes increased and tax thresholds did not follow. According to the data, the income tax elasticity – that is, how much tax revenue increases for every 1% increase in income – went from 1.8 in 2019 to 2.0 in 2023. In other words, government revenues increased disproportionately, not because people got richer, but because the law did not adjust for inflation.

70% of tax erosion in 2023 came from taxpayers shifting to higher brackets, compared to just 20% in 2019. The effect mainly affected low and middle incomes, where tax deductions have a substantial weight and moving to higher brackets causes a noticeable burden.

About the tax reforms of the period – such as the rate cuts, the new scale, and changes to collections – the Bank points out (implicitly but explicitly) that the absence of institutionalised indexation compounds the problem. Income tax revenues held steady at 5.9% of GDP, while the average effective tax rate fell marginally to 8.7%. However, the erosion of tax fairness remains real and is operating sub-optimally.

The BoE does not make an explicit proposal for a permanent indexation mechanism, but stresses the need to incorporate the measurement of tax erosion into medium-term fiscal planning. As noted, accurate quantification of the phenomenon can improve revenue forecasts and support fairer and better-targeted policies. At the same time, the BoE acknowledges that the increased progressivity of tax policy over the last five years has had a counterbalancing effect, contributing to reducing inequalities. Something that also works as a recommendation.

The BoE’s intervention takes on political significance, as, according to reports, the relevant changes are already being prepared at the Ministry of National Economy and Finance and are expected to be announced by Prime Minister Kyriakos Mitsotakis at this year’s DETH. On the table is the indexation of the tax scale and a new progressive scale for property income.