Governing on autopilot? Flexibility and stability under different indexation regimes

Automatically adjusting taxes and social transfer programs using a price index is a common method to keep their real value from being eroded by inflation.

Proponents argue that such indexation provides more stable welfare system, while their critics mean that it hurts the government’s fiscal room of maneuver.

Yet, no one has investigated these claims.This project is the first empirical investigation into the costs and benefits of indexation.

We will put together a dataset with annual program-specific panel data on social transfers, taxes and minimum wages; covering most EU or OECD countries and spanning multiple decades.

Using well-established econometric methods for panel data, we will then analyze how indexation affects the (real) volatility and trajectories of social transfers, tax brackets, and minimum wages, on the one hand, and the electoral cost of cut-backs as well as the speed of fiscal consolidations and reallocations, on the other.These studies test central assumptions in the literature on welfare state reform.

The project’s theoretical contribution is to show how the economic concept of nominal rigidities is fruitful also for understanding political decision-making, and that the real-term fluctuations that arise in taxes and transfers due to these rigidities can represent a substantial social welfare cost.The project will be carried out over four years by the two political scientists Pär Nyman and Axel Cronert, initially with the help of a research assistant.