Inflation and the Indexation of Personal Income Taxes in Theory and Practice

The impact of inflation on taxpayers’ liabilities can be measured in at least two different and often contrasting ways. On the one hand, it can be measured by the percentage increases in the average tax rates. On the other hand, it can be measured by the percentage points, that is the absolute increases in those rates. Although the former has attracted more attention, it is the latter that is more significant in regards to the effects on disposable incomes and after-tax income distribution. Much of the controversy regarding indexation has revolved around the issue of stabilization. Some have argued that indexation poses real dangers to stability while others have pointed to its positive potential. The author looks at analytical adjustment schemes and analyses practical applications of indexation, arguing that the case for or against indexation of the personal income tax cannot be made in abstract as the consequences of indexing differ among countries.