Inflation and Europe’s Personal Income Taxes

Most countries’ personal income taxes have a progressive structure where tax rates increase as individuals earn higher wages. However, if wages are pushed up by inflation, people may pay higher taxes even if their real earnings have not increased. This is known as bracket creep.

In the first quarter of 2022, labor costs in the European Union rose 4 percent over the prior year while a July report revealed a 9.8 percent annual increase in consumer inflation. With continued concerns over inflation, individuals may be wondering how their tax bills will be impacted.

Only 11 out of 27 European OECD countries automatically adjust income tax brackets for inflation every year. Germany adjusts its income tax brackets every two years in response to an inflation report, but it also has the flexibility to adjust rates more regularly (as it has done in recent years). For countries with flat taxes (e.g., Czech Republic, Estonia, and Hungary), this is less problematic: there are no higher brackets into which rates can creep.

That leaves 14 European OECD countries that do not adjust their income tax brackets for inflation regularly. The United Kingdom joined this group when it paused inflation adjustments for four years, starting in 2022. Austria has recently adopted inflation adjustments that will apply beginning in 2023.

Politicians may welcome bracket creep because they can appear to cut taxes every couple of years when, in reality, they are simply bringing income tax brackets more in line with inflation. A better approach would be to automatically adjust income tax brackets for inflation. This would give taxpayers more certainty and keep politicians honest.

The German term for bracket creep—“Kalte Progression” or “cold progression”—suggests the coming of winter. As inflation remains high, more governments should help taxpayers stay warm by indexing income tax brackets to inflation.