fiscal drag

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Related to fiscal drag: Contractionary fiscal policy

Fiscal Drag

Reduced activity in an economy as a result of a progressive tax system set up in such a way as to penalize extra earnings. For example, suppose a gross income more than $50,000 per year increases one's tax liability such that a person effectively earns less than he/she would have at $45,000 gross. A rational economic actor would therefore endeavor to lower his/her gross income. This in turn lowers spending and reduces the supply of money in an economy available to purchase goods and services. The diminished activity is called fiscal drag.
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fiscal drag

the restraining effect of PROGRESSIVE TAXATION on economic expansion. As NATIONAL INCOME rises, people move from lower to higher tax brackets, thereby increasing government TAXATION receipts. The increase in taxation constitutes a ‘leakage’ (from the CIRCULAR FLOW OF NATIONAL INCOME) that will reduce the rate of expansion of AGGREGATE DEMAND below that which would otherwise be the case. Governments may choose as part of FISCAL POLICY to adjust for the effects of fiscal drag by regularly increasing personal tax allowances.

Fiscal drag can also serve to automatically constrain the effect of the pressure of INFLATION in the economy, for with a high rate of inflation people will tend to move into higher tax brackets, thereby increasing their total taxation payments, decreasing their disposal income and reducing aggregate demand. This has the effect of reducing the pressure of DEMAND-PULL INFLATION. See AUTOMATIC ( BUILT-IN) STABILIZERS.

Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in periodicals archive ?
Continued progress in reforms, lower fiscal drag, and stronger external demand, especially from the Euro area, are expected to support the recovery.
Chang said the government was highly likely to face fiscal drag in the fourth quarter due to shortfalls in tax revenue and the front loading of the budget in the first half of this year by 58.
Momentum in the US equity market can continue if companies see improved top-line growth as a result of pent-up demand, realization that interest rates will eventually rise, diminished fiscal drag and more balanced global growth.
| DAVOS, Switzerland, Jan 24 (KUNA) -- The US economy will have a good year in 2014, spurred by strong core growth, rising confidence and an end to the fiscal drag, Jacob J.
This pickup is partly thanks to a reduction in the fiscal drag that will result from the recent budget agreement.
"The fiscal drag in 2013 took 1.5 percentage-points off GDP growth.
"Notably, despite significant fiscal headwinds, the economy has been expanding at a moderate pace, and we expect that growth will pick up somewhat in the coming quarters, helped by highly accommodative monetary policy and waning fiscal drag."
The deficit as a fraction of GDP fell from 8.7 percent in fiscal year 2011 to 7.0 percent in fiscal year 2012, for a total of 1.7 percentage points of fiscal drag. This fiscal drag partly came from reductions in automatic stabilizers in the budget as the economy recovered, but it mainly came from the wind-down of spending from the Recovery Act.
In the US, the fiscal drag (which shaved off around 1.75% of GDP in 2013) is due to ease gradually and most analysts expect higher economic growth.
"A recovering housing market and consumer and business spending are driving economic growth, providing some relief from the considerable federal fiscal drag in the form of mandated sequestration spending cuts and higher payroll taxes than last year that continues to slow both state and national growth.''
The modest improvement of global growth projected for next year is expected to be supported by the maintenance of highly accommodative monetary policies in key advanced economies, by the fiscal stimulus being implemented in Japan, and by the waning of fiscal drag in the United States and the Euro Area.
First, we'll need a pickup in consumer activity and, second, we'll need a fall-off of intensity of fiscal drag."