Understanding Fiscal Drainage: The Hidden Cost of Living Increases in Italy
In recent years, Italy has witnessed a gradual rise in the cost of living, which has led to a slight increase in wages for many workers. However, this wage growth may not be felt by a significant portion of the population. The reason? A dual impact of rising taxes and a phenomenon known as fiscal drainage. As incomes rise, so too do the taxes owed, particularly under a progressive tax system which defines that higher earnings mean higher tax rates. Unfortunately, this dynamic often leads individuals to find less disposable income than expected, especially among the medium and low-income earners who see a larger percentage of their wage increases absorbed by taxes.
According to a report from the Parliamentary Budget Office, this year could pose even greater challenges. Italy's taxation system is structured in three brackets: 23% for incomes up to €28,000, increasing to 35% for incomes from €28,000 to €50,000, and reaching 43% for incomes above €50,000. As inflation drives the cost of living higher, wage increases have not kept pace. From January 2021 to January 2025, prices increased by 168%, while wages have only risen by 82%, creating a significant gap that individuals must navigate amidst rising costs.
While many people may welcome any wage increase, the reality is that the increase might push them into a higher tax bracket, reducing the overall benefit of that raise. This phenomenon, termed fiscal drainage, undermines the equity that the tax system aims to provide. When inflation eats away at the purchasing power of wages, the implications can lead to fewer resources for those who are already struggling, as they compete to maintain their standards of living.
Fiscal drainage is particularly harsh on low and medium incomes where individuals risk surpassing bonus thresholds or losing deductions. Those earning above €50,000, while facing the highest tax bracket, do not confront the same risks. For the year 2024, it is predicted that those with incomes between €35,000 and €70,000 will bear almost two-thirds of the total income tax burden. This places a disproportionate burden on middle-class wage earners compared to their wealthier counterparts, creating a scenario where the burden of tax revenue falls heavily on those who cannot evade taxes.
The increase in tax revenues—an estimated €17 billion in 2024—has been facilitated by fiscal drainage. The government's recent tax interventions, projected to further increase state revenue, have predominantly relied on this phenomenon without providing significant relief to the average worker. The recent restructuring of the tax brackets, while seemingly beneficial, continues to create challenges amid persistent inflation.
Economists are urging for a reevaluation of the income brackets and bonus thresholds within the tax system to reflect the reality of rising wages driven by inflation. This adjustment, while financially costly, could restore balance and ensure that wage increases translate into real improved economic situations for workers rather than simply lining the state's coffers. Without such adjustments, the cycle of fiscal drainage could continue to erode the financial stability of the middle and lower income brackets, who are the backbone of Italy's economy. The challenge lies ahead for the current government to address this ongoing concern and create a monetary system that is equitable for all citizens.
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