One of the biggest beneficiaries of inflation is the state. When prices for groceries, rents, insurance, services or mobility rise, the treasury earns twice over. Not only because VAT is due at all, but because the absolute share has continued to rise because of higher spending. When we then try to offset our own price increases through a wage increase so that we do not end up in a squeeze at the end of the month, the state continues to tax the nominal increase. Through the wage increase, one may have gained nothing in real terms, but the tax slip still shows a higher income with higher deductions. In real terms, the employee has hardly become richer, but for tax purposes he looks richer.
For wealth building, this is a creeping process in the wrong direction. Anyone who is merely defending purchasing power has not yet gained additional capital. If an additional part of this compensation lands with the state, less remains for reserves, stocks, real estate, private retirement provision or one’s own business activity. Work then turns into real, productive ownership ever more slowly.
What fiscal drag means
Income tax in Germany is progressive. As income rises, not only the absolute tax rises, but also the tax rate on additional parts of income. The next euro earned can therefore be taxed more heavily than the first euro of income. That is politically intended. Those who earn more are supposed to contribute proportionally more. An employee with 50,000 euros of taxable income needs around 1,100 euros more income at 2.2% inflation just to roughly maintain purchasing power. 50,000 euros becomes 51,100 euros. Under the 2025 income tax schedule, the tariff income tax in this simplified example rises from around 10,691 euros to around 11,083 euros. That is about 392 euros more tax on an increase that in real terms is mainly inflation compensation.
This example is deliberately simple and contains no social security contributions, no church tax and no individual allowances. But it clearly shows that when prices and wages rise nominally, the tax base grows. Without a complete shift in the tax schedule, the state earns from monetary devaluation.
That is exactly fiscal drag. The higher tax amount alone is not the problem; the absurdity is that more tax is due even though real ability to pay has hardly increased.
Inflation does not only hurt in the supermarket
Inflation is felt wherever something is paid for. Shopping costs more, insurance becomes more expensive, rent rises, a restaurant visit becomes a luxury. But that is only the visible part of inflation. When companies and employees negotiate higher wages because the cost of living has become more expensive, nominal incomes rise. Payroll tax and income tax are due on these incomes. The state is therefore not only on the cost side, but also on the revenue side.
This makes matters politically easy, because while a planned tax increase often provokes resistance among the population, fiscal drag works without any additional action. State revenues rise because the tax bases rise. Later the state can even return part of it through shifts in the tax schedule and sell this plan as relief. In the end, politics can reward itself for its failure.
The state offsets it, but not as a matter of principle
In the past, the income tax schedule was often adjusted – most recently under the traffic-light coalition with Finance Minister Christian Lindner, and despite fierce criticism from the left and green camps, which wanted to prevent people with higher incomes from also being relieved. For 2026, the basic allowance was at least shifted from 12,096 euros to 12,348 euros in order to soften the effects. That is good, but it does not fully solve the underlying problem. While prices rise continuously, changes to the tax schedule come by law and therefore always with delay, exceptions and political room for maneuver.
The Federal Ministry of Finance itself even describes fiscal drag as additional tax revenue that arises when incomes merely compensate for inflation and the average burden nevertheless rises. This means it is officially acknowledged: the state can benefit from inflation for tax purposes.
More salary is not more prosperity
For many households, a salary increase at first glance always means progress, or at least relief in the monthly household budget. In an inflationary phase, however, this calculation often does not hold, because prosperity only grows when income after taxes, contributions and price increases rises in real terms – and does so truly noticeably. A 4% wage increase with 2.2% inflation is only a limited jump before deductions. After taxes and social security contributions, less of it remains. If rent, insurance or mobility rise more strongly than the average, the situation can become tighter despite a higher salary.
This is exactly where the connection to wealth building lies. Wealth does not arise from gross income, but always from the part of net income that remains after all everyday expenses have been deducted and can be invested regularly. Fiscal drag presses on this remainder, can even make additional saving impossible, and always worsens the starting position for people who want to build wealth from work. This does not only affect top earners; it affects the working middle.
Why the state earns from inflation
Inflation is not only pleasant for the state. Its costs also rise. Construction projects become more expensive, personnel costs more, social benefits have to be adjusted, interest rates can rise. Nevertheless, the state benefits in several places from nominally higher values. When prices rise, VAT revenues rise on higher sales. When wages rise, payroll tax and social security contributions rise. When corporate revenues grow nominally, tax bases can also become larger.
Fiscal drag is part of this pattern. It turns monetary devaluation into an additional burden. First, additional revenues arise through inflation, then the state gives part of them back. For citizens, the experience often remains: prices are higher, the salary is higher, but free room for maneuver hardly grows. This is pure redistribution logic.
What employees can learn from this
A salary increase is progress only when it creates more free saving capacity after inflation, taxes and contributions. Anyone who earns 4% more should therefore not automatically plan 4% more standard of living. Part of the increase does not mentally belong in new consumption at all, but in preserving old purchasing power. Only the real surplus beyond that can enable additional wealth building. A system that heavily burdens current income does not reward looking at gross income. It rewards looking at the amount that is truly left after all deductions.
For private investors, this means that salary increases must be calculated through. How much more net income remains? How strongly have one’s own costs risen? How much additional savings rate is really possible? Only this figure shows whether the wage increase was a step forward or merely an expensive compensation for more expensive living.
Not every wage increase is a gain in prosperity. For the state and politics, however, inflation is always good, especially when it later comes to trying to cushion it.
