ACCA Applied Knowledge · Business and Technology · Macroeconomic factors
During a period of rising wages and inflation, a government does not adjust its income tax thresholds. More workers find part of their income taxed at higher rates, so tax revenue grows faster than incomes. What is this called?
This is fiscal drag. When income tax thresholds are not raised in line with wages or inflation, more income falls into higher tax bands, so tax revenue rises faster than incomes and real disposable income is squeezed. It is not crowding out or automatic stabilisation.
- ACrowding out
- BAutomatic stabilisation
- CFiscal dragCorrect
- DProgressive devaluation
Explanation
Fiscal drag arises when tax thresholds are not indexed to inflation or earnings growth, pulling taxpayers into higher bands and reducing real disposable income. Automatic stabilisers are built-in changes in taxes and benefits over the economic cycle, which is a different idea.
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