Relief for the middle class: a funded income tax reform for Spain

Miriam González put it plainly at the launch of Democracia 21 in Madrid on 10 October: Spain's middle class is squeezed and needs tax relief, as we set out in our overview of the party's proposals. The goal is right. Relief that a country with a deficit cannot pay for is a gift that comes back as cuts or debt, so the radical-centre version comes with its bill attached. Yesterday's explainer on the tax wedge showed how much of an average wage goes in tax and contributions. This proposal deals with the part of that burden that rose without anyone voting for it, and with how to give it back.

The rise nobody voted for

Spanish income tax is written in euros. The thresholds of each bracket, the personal and family allowance (€5,550 for a single taxpayer, per the IEB paper below) and the earned income deduction for workers are fixed amounts. When wages rise with prices, those fixed amounts shrink in real terms and the average rate creeps up, even for someone whose pay buys no more than before.

Sofía Balladares and Esteban García-Miralles measured this with Spanish tax records in a 2025 IEB working paper. Against a scenario in which every parameter had been indexed each year since 2019, IRPF raised about €10.6 billion more in 2023, equal to 0.73% of GDP and roughly a third of the tax's growth. The adjustments governments made offset only around 30% of the drag.

The detail that matters for the middle class is where it lands. The authors find that in Spain the drag comes mainly from deductions, above all the earned income deduction and the personal and family allowance, and that the tax's sensitivity to nominal growth peaks in the middle of the distribution, especially between the 30th and 45th percentiles, where the extra work deduction phases out. A €2,000 general deduction for work loses value every year that prices rise. Bracket creep matters more near the top; the middle loses through its allowances.

The paper also notes that Spain, like Italy and Portugal, updates its tax parameters at the government's discretion, while the Nordic countries, Belgium and the US do it automatically or by rule. Germany adjusts on the basis of two official reports every two years, so that subsistence income stays tax-free.

F. A. Hayek saw the political problem in The Constitution of Liberty. As Eugene Miller's account for the Institute of Economic Affairs summarises it, Hayek held that a just tax follows a rule that applies to everyone, that the majority deciding the total should bear it too, and that inflation quietly brings the middle classes under higher rates without raising their real income. The same account records something often forgotten: Hayek accepted that some progression in income tax is probably justified to offset the weight of indirect taxes. That concession is the hinge of this proposal.

The swap, euro by euro

The proposal has three parts, and they go through Parliament together.

First, an indexation law. Every year the bracket thresholds, the personal and family allowance and the earned income deduction rise with the previous year's inflation, automatically. The Cortes can still freeze them, by an explicit vote in the budget that states how much revenue the freeze raises. Fiscal drag becomes a decision with a name and a number.

Second, return the accumulated drag to the people who paid it. Relief goes first through the personal allowance and the earned income deduction, the two parameters where the IEB paper finds the middle lost most, and phases in over a legislature. The full figure is about €10.6 billion at 2023 incomes; each year's budget states how much has been returned and how much is left.

Third, pay for it from tax breaks that do their job badly. AIReF's 2020 spending review, as reported by Ara, put the cost of Spain's reduced VAT rates at €17.8 billion a year and of six IRPF tax breaks at €8.4 billion. AIReF found that reduced VAT rates do help people buy essentials, but inefficiently, because better-off households spend more and so capture more of the benefit. It recommended phasing out the joint filing reduction, which discourages women from joining the labour market, and a complete redesign of the pension plan deduction, which fails to boost long-term saving. The government has already committed to Brussels to raise 0.1% of GDP, about €1.6 billion, by reforming tax breaks.

Recovering a third of what reduced VAT rates cost would bring in, on AIReF's figures, around €6 billion. Phasing out joint filing and redesigning the pension deduction adds more. Together that covers most of the returned drag; the indexation law then keeps it from building up again. These are 2020 cost estimates, so the first step is for the Tax Agency to publish updated figures for each break, and the swap is calibrated on those.

Low-income households need protecting from any VAT change, and the IMF says so too. Its 2026 Article IV statement on Spain found that harmonising VAT rates by removing reduced rates on many products could deliver most of the consolidation still pending in Spain's medium-term fiscal plan at a small cost to growth, with transfers offsetting the impact on the poorest, and it recommends a refundable in-work tax credit for low-income households. A share of the extra VAT goes there first. Hayek's concession fits: as indirect tax rises a little, income tax stays progressive to balance it.

Against the other offers

The PP's plan of March 2026, as reported by El Español from a party working document, would deflate the first three brackets, lift the personal allowance to €6,150 and double the allowances for children, returning about €3.2 billion, 85% of it to filers under €60,000. It also proposes cutting VAT on fuel, electricity and gas from 21% to 10%. The report describes no funding, and the VAT cut widens exactly the kind of break AIReF found poorly targeted.

Izquierda Unida's fiscal reform document of November 2025 goes the other way: higher state rates on labour income above €200,000, the end of the pension plan deduction, which it values at €850 million, and VAT on household electricity down to 5%, within a package of €111 billion of extra revenue. It takes pension relief away from savers, and it adds a new reduced rate.

Democracia 21 has set the goal and, so far as we have seen, has yet to publish the costing. Ours puts the relief where the drag fell, pays for it with breaks that mostly help those who need help least, and changes the rule so that the next rise has to be voted on. That is how Mario Draghi's case for productivity reaches the payslip: work that pays a little more after tax, financed without borrowing from the next generation.