The impact of indexation of personal income tax and social security contribution parameters on effective taxation

Personal income in the member states of the European Union is subject to personal income tax and social security contributions. Individual parameters of these tax systems (such as tax brackets, tax deductions, tax credits, or assessment bases) may be indexed according to predetermined rules, most commonly in relation to inflation or wage growth. The main objective of this thesis is to determine whether and how the indexation of tax parameters affects the development of effective taxation of income. The first part of the thesis defines the basic principles of personal income tax, social security contributions, and their variability across EU member states. It subsequently explains the concept of the effective tax rate and its distinction from nominal taxation. Furthermore, the theoretical framework of indexation and the possible forms of indexation of tax parameters are introduced, including the reasons for implementing indexation. The second part of the thesis describes the data collection methodology and explains the sources used. Information on whether individual states index tax parameters was obtained from the EUROMOD microsimulation model. EUROMOD is a model managed by the European Commission that focuses on the analysis of the effects of tax and social policies in EU countries at the household level. Data on inflation and data necessary for the calculation of effective taxation were obtained from OECD and Eurostat databases. Based on these data, the thesis evaluates the extent to which individual member states apply automatic indexation of tax brackets, tax reliefs, and social security contribution assessment bases. The final chapter focuses on a comparative analysis of the development of effective tax rates and whether the indexation of tax parameters influences this development. In addition, four regression analyses are conducted based on the selected taxes and groups of states that either apply or do not apply indexation. The aim of the analysis is to determine whether inflation and average wages affect the development of effective taxation. The results of the thesis show that approaches to the indexation of tax parameters differ significantly across the European Union. Based on the comparison of the development of effective tax burdens, it cannot be concluded that indexation itself guarantees a linear development of effective taxation. The regression models did not reveal a statistically significant relationship between effective taxation and the independent variable in states where tax parameters were indexed, which was in line with the expected outcomes of the models. No relationship was identified in states that did not index social security contribution parameters either. A relationship was identified only in the case of states that did not index personal income tax parameters however, contrary to expectations, the relationship was inverse, meaning that effective taxation decreased as inflation increased. This result suggests that the development of effective taxation is influenced by multiple factors, or that in states without automatic indexation more frequent discretionary tax changes may occur, reducing the impact on the effective tax burden. From the perspective of the overall comparison, it cannot be clearly confirmed that the indexation of tax parameters had a universally strong effect on effective taxation in the period 2010–2019. Nevertheless, in line with theoretical assumptions, indexation functions as a mechanism preventing the unintended increase of the tax burden during periods of rising prices or wages. The thesis therefore contributes to the discussion on the importance of indexation in tax policy and provides an overview of existing practices in the member states of the European Union.