The Hidden Effects of Inflation. An Examination of Bracket Creep and its Implications for the Income Tax: Evidence for Spain (1979-1987)

Abstract: This paper examines the impact of inflation on the income tax in Spain from 1979 to 1987. By introducing a new approach using dynamic microsimulation and the Elasticity of Taxable Income (ETI), we analyze three dimensions of the tax: revenue, progressivity, and redistribution. The microsimulation reveals that the lack of adjustment of the income tax to inflation: 1) accounts for 44% of the increase in revenue 2) shows negligible changes in the progressivity, due to two compensating effects (credits and schedule) that mainly affect the extremes of the income distribution and 3) explains 70% of the increase in redistribution. We estimate an ETI equal to 0.2, predicting small changes in taxpayer behavior in the face of changes in tax rates. This ETI is significantly lower than that found for more recent periods in Spain. Extending the microsimulation with the ETI minimally changes the results.