Fiscal drag is an economics term referring to a situation where a government’s net fiscal position (equal to its spending less any taxation) does not meet the net savings goals of the private economy. This can result in deflationary pressure attributed to either lack of state spending or to excess taxation.
One cause of fiscal drag is the consequence of expanding economies with progressive taxation. In general, individuals are forced into higher tax brackets as their income rises. The greater tax burden can lead to less consumer spending. For the individuals pushed into a higher tax bracket, the proportion of income as tax has increased, resulting in fiscal drag.
Fiscal drag is essential a drag or damper on the economy caused by lack of spending or excessive taxation. As increased taxation slows the demand for goods and services, fiscal drag results. Fiscal drag is a natural economic stabilizer, however, since it tends to keep demand stable and the economy from overheating.
Fiscal drag has the effect of reducing (or limiting increase) in aggregate demand and becomes an example of a mild deflationary fiscal policy. It could also be viewed as an automatic fiscal stabilizer because higher earnings growth will lead to higher tax and therefore moderate inflationary pressure in the economy.
Because fiscal drag can operate as an economic stabilizer, fiscal drag can influence economic equality among citizens of the same region.