Inflation is back, but this time fiscal drag won’t even cover the cost of scrapping road tax

Yesterday morning, whilst reading the newspapers, members of the public were struck with fear at the enormous ‘blow’ the government was about to face; there must have been some who rejoiced at the unexpected ‘windfall’ to spend on the election campaign. Both reactions are unjustified, because La Repubblica’s headline is greatly exaggerated: “Torna la tassa invisibile: stangata da 13 miliardi su stipendi e pensioni”. The argument is that in the two-year period 2026–27, fiscal drag will, once again, fill the Treasury’s coffers with extra revenue. There will certainly be an effect, but it will be much more modest—probably by an order of magnitude. The figures laid out—those published ten days ago by Marco Leonardi and Leonzio Rizzo in these pages—are correct, but the interpretation is out of proportion: the fiscal drag will amount to between 2.5 and 5 billion euros over the two-year period. 

Let’s start with the concept of ‘fiscal drag’. This is a sort of invisible tax, resulting from the interaction between general price rises and the progressive tax system. In fact, if incomes rise in nominal terms to recoup the purchasing power eroded by inflation, and if, at the same time, the thresholds for income tax brackets and allowances are not updated, a larger proportion of one’s salary is taxed at higher marginal rates. In essence, real disposable income grows at a slower rate than gross nominal income: the tax burden increases and the state finds itself with additional revenue without having voted for any tax increase.

Fiscal drag is, of course, less pronounced when inflation is low and far more significant when it is high. It is no coincidence that this was a much-studied and widely discussed phenomenon in the 1970s and 1980s, which has only returned to the fore in recent years following the post-Covid and post-war surge in inflation in Ukraine. Normally, with an inflation rate in line with the ECB’s 2 per cent target, fiscal drag amounts to around 3 billion per year (3.2 billion following the Meloni government’s latest tax reform, which increased the progressivity of personal income tax). Meanwhile, following the years of high inflation in 2022–2023, the cumulative fiscal drag, according to calculations by Leonardi and Rizzo, amounted to around 25 billion euros, which the Meloni government used to implement a tax reform (a reduction in social security contributions, later incorporated into personal income tax, and a cut in tax rates) which more than offset the fiscal drag for low-to-middle incomes (below 35,000 euros per annum) whilst penalising middle-to-high incomes (above that threshold).

And now, how much does this fiscal drag amount to? Following the disappointment of a 3.1 per cent deficit in 2025, can the government build an election campaign around this and win the elections? Leonardi and Rizzo calculate, based on the latest estimates from the Bank of Italy – which forecasts cumulative inflation of 5.2 per cent in its baseline scenario (3.1 per cent in 2026 and 2 per cent in 2027) – that the fiscal drag will amount to 8.1 billion. In an adverse scenario, which assumes a rise in energy prices, cumulative inflation over the two-year period would rise to 6 per cent and the fiscal drag would be 9.3 billion. Whereas in a severe scenario – that is, with a 60 per cent increase in the price of oil and a 100 per cent increase in the price of gas compared with the baseline scenario – the fiscal drag would rise by 12.7 billion. This figure corresponds exactly to the 13 billion cited in the La Repubblica headline, which factors in cumulative inflation of 8.2 per cent: 4.4 per cent for 2026 (considered unrealistic at this stage of the year) and 3.8 per cent for 2027 (nearly double the baseline scenario).

But even taking these extreme scenarios into account, such a ‘windfall’ would never materialise. Because, as mentioned at the outset, there is a sort of underlying fiscal drag based on normal inflation (below 2 per cent, according to the ECB’s target). If we look at the tables in the October 2025 Draft Financial Plan (DPFP), the Minister for the Economy, Giancarlo Giorgetti – who obviously could not have foreseen the crisis in the Middle East and the closure of the Strait of Hormuz – drew up a Budget Bill forecasting cumulative inflation of 3.5 per cent over the two-year period 2026–27. This means that, for this two-year period, the public finance trends already incorporate around 5.5 billion in fiscal drag. Consequently, the Bank of Italy’s baseline scenario – with inflation of 3.1 per cent this year and 2 per cent next year – implies a total of around 2.6 billion in additional revenue for the two-year period 2026–27 compared with the ‘normal’ fiscal drag.

With 1.3 billion a year, Meloni and Giorgetti certainly cannot draft an electoral Budget Bill; at a push, they might be able to fund a partial abolition of the road tax on a first car (which costs around 2.4 billion each year). But this is neither a ‘hefty tax hike’ nor a ‘hidden windfall’.