Inflation can be regarded of as a hidden tax for unrestrained government action, as Nobel Laureate Milton Friedman proposed in a speech during the period of rising prices in the 1980s.
Why is inflation called a hidden tax?
Inflation is referred described as a “hidden tax” by some. It does not require legislation from Congress or the states, unlike other taxes. It isn’t deserving of a line on the 1040 federal income tax form, which many Americans will submit this week. It also doesn’t reflect as a % markup on the items we buy on the bottom of sales receipts.
Nonetheless, it drains resources from the economy and redirects them to less productive activities, much like a tax. It distorts pricing signals and causes capital misallocation. It’s a quiet way for the government and central bank to weaken the currency, hike prices, assist borrowers while punishing savers.
The official campaign for increased inflation as a remedy for the United States’ sluggish recovery began roughly two years ago with a study titled “Rethinking Macroeconomic Policy” by IMF researchers, including Chief Economist Olivier Blanchard.
Ken Rogoff of Harvard (does he think this time is different?) and Greg Mankiw, an economic adviser to President George W. Bush, are among many who have gotten on board. Higher inflation, they believe, would hasten the deleveraging process by allowing debtors, such as the US government, to repay their loans in depreciated dollars. (Borrowers get a 1, savers get a 0)
Another proponent of higher inflation, Princeton University’s Paul Krugman, claimed in a New York Times essay on April 5 that 3% or 4% inflation would “almost certainly assist the economy.” This would be accomplished by degrading the real worth of debt and dissuading firms and consumers from hoarding cash.
Think about what 6 to 8% inflation could accomplish if 3 to 4% inflation can do all that!
One of the drawbacks with aiming for a little more inflation is that you can wind up with a lot. Excess reserves, or inflation tinder, amount to $1.5 trillion on the Federal Reserve’s balance sheet. Banks will eventually find a more profitable method to exploit the 0.25 percent interest-paying deposits at the Fed: issuing loans, for example, which expands the money supply.
“It took three decades for people to believe the Fed was serious about committing to a long-term inflation aim of around 2%,” Jim Glassman, senior US economist at JPMorgan Chase & Co., says. “Never again would you listen to what the central bank said,” he adds if the Fed breaks its word. “A bigger risk premium would be demanded by investors.”
All of this, according to Glassman, sounds like something made up in the classroom, which it is. Raising inflation expectations lowers the real funds rate, which is already negative, and makes borrowing more appealing because the nominal funds rate cannot go below zero. So much for the much-needed debt reduction.
What about long-term interest rates, which appear to be the Fed’s main focus? The yield curve would steepen as nominal long rates adjusted to reflect increased inflation expectations, and the Fed, fearful of increasing mortgage rates, would initiate QE7, or whatever round of quantitative easing we’re on at the time.
Take a step back from the “how to” debate and contemplate the “why.” When the government prescribes the same policies that led us into this trouble as the remedy, something is profoundly wrong. The United States is living beyond its means. For the fourth year in a row, the federal government has a trillion-dollar deficit, compounding its failure to keep promises made to future retirees. Because home ownership was promoted as a reliable piggy bank, consumers went on a credit spree. All of the financial crisis postmortems underlined the need to save more and consume less.
Nonetheless, how come the road to abundance suddenly passes via Debtville and Inflation City? All of the incentives are pointing that way. Since December 2008, the Fed’s benchmark rate has remained between 0 and 0.25 percent. If Federal Reserve Chairman Ben Bernanke has his way that is, unless events force him to change his mind it will remain at zero until late 2014, a period of six years.
Would anyone in the financial markets have believed you 25 years ago if you told them the US economy would require near-zero interest rates for this long?
The Fed should not push us to spend, spend, spend if we need to conserve more, both personally and as a country. (Borrowers get a 2, savers get a 0) And some economists want to add more inflation to this poisonous mix?
Smart people, not conspiracy theorists, have begun to ask if Bernanke isn’t ready to err on the side of higher inflation to assist the US government pay off its $15.6 trillion debt. That is not a good way to build a reputation.
Bernanke is a history buff, and the Great Depression chapter currently has more dog-eared pages than the one on 1970s stagflation. That’s unfortunate because, according to Marvin Goodfriend, a professor of economics at Carnegie Mellon University in Pittsburgh and a former research director at the Richmond Fed, there’s enough historical “data Bernanke might utilize to start withdrawing before inflation gets ahead of him.”
Pre-emption does not appear to be part of Bernanke’s toolset. Maybe he has an extraordinary sense of timing, but if history is any indicator, the Fed will be late in normalizing interest rates. As a result, when we pay our taxes next year, we should expect to see part of that hidden inflation tax.
(Caroline Baum is a Bloomberg View writer and the author of “Just What I Said.”) Her views are entirely her own.)
What is the definition of a hidden tax?
Cigarettes, alcohol, gambling, gasoline, and hotel rooms are all examples of hidden taxes. These taxes are frequently collected as part of a routine transaction, burying them in the final price, which is greater than it would be without the hidden tax.
What role does inflation play as a tax?
When redistribution leads in goods and services being moved from the people to the government, inflation acts as a tax. It is borne primarily by those who are least able to pay. It acts as a tax on the people and transfers purchasing power to the government when the government issues more money to finance its budget deficit, repay its past debt, and fulfill increased demand for goods and services during inflation.
Inflation is a form of tax.
If you think the term “inflation tax” just refers to the effect of inflation on the purchasing power of your income and savings, you should keep reading.
Inflation is a genuine tax, just as real as, and sometimes even more significant than, individual income taxes. While inflation reduces the purchasing power of your earnings and the value of your fixed-income assets, it also transfers purchasing power from firms and people to the federal government. And, with inflation at 5.4 percent in today’s economy, the inflation tax is no small thing. In 2021, the government will earn more than $1.9 trillion from the inflation tax.
The majority of individuals are aware that inflation has the potential to redistribute income and wealth. Many people are presumably aware that unexpected inflation favors borrowers at the expense of creditors. Borrowers repay debt with future dollars that have less purchasing power when inflation is higher than predicted…
What happens to taxes when prices rise?
Most Indiana local governments rely heavily on property taxes, and they were concerned about the impact of the COVID recession on property tax receipts.
However, growing property values in 2020 will result in higher assessed values in 2022, which will result in higher tax obligations. Indiana’s income grew in 2020 as a result of the federal COVID relief bills, hence the state’s property tax revenue ceiling will continue to rise in 2022. Because many jurisdictions’ tax rates are expected to decline next year, fewer people will be eligible for tax cap benefits. Local governments will be able to collect a larger portion of their tax revenues. It appears like the recession will not be an issue in 2022.
We’ve never had to deal with high inflation before. The property tax in Indiana today is very different from what it was during the 1970s, when inflation was extremely high. So let’s give it some thought.
Assume that there is “pure inflation,” which means that prices, incomes, and property values all rise at the same rate. It’s not going to happen, but it’s a fun experiment to see how inflation affects people.
Assume that property values rise in tandem with inflation. The assessed values are increasing. Because the maximum levy is calculated based on income growth, it rises with it. Tax rates remain unchanged if the levy and assessed value rise at the same rate. As assessed values rise, so do constitutional tax caps, resulting in higher tax obligations.
Inflation would be aggravating, yet nothing happens. Local governments will be able to cover their increased costs with the additional money. Property taxes remain unchanged as a percentage of inflated property values and earnings.
What could possibly go wrong? Any aspect of the tax system that isn’t adjusted for inflation. There are four that come to mind.
Assume that in 2021, inflation raises property values. This growth is being measured by assessors for assessed values in 2022. In 2023, those assessed values will be utilized to calculate tax bills. Until then, assessments will not be able to account for current inflation.
Second, the state caps property taxes at a maximum levy, which rises by a percentage called the maximum levy growth quotient every year. The Department of Local Government Finance determined a six-year average of Indiana non-farm income growth. The MLGQ for 2023 will be calculated by the DLGF in summer 2022, based on the most recent six income growth data, from 2016 to 2021.
That means the property tax levy will not begin to reflect inflation in 2021 until 2023. Even then, there will be one year of high inflation and five years of low inflation in the six-year average.
Inflation is increasing the cost of municipal government now, in 2021. Contracts may fix certain expenses, but many must be rising. Local governments will not have enough revenue to cover inflation for at least two years if assessments and maximum levies do not adapt.
We’re losing optimism that the inflation is only temporary, but let’s assume it fades away in 2022 and returns to the 2% level by 2023. Based on what transpired in 2021, assessments and the MLGQ will rise. Budgets for local governments would begin to catch up.
But what if inflation continues to rise? Assume it continues till 2028. At that point, the MLGQ’s six growth rates would all incorporate inflation. Maximum charges would eventually climb to compensate rising costs.
Except for the third problem. The MLGQ is limited to a maximum of 6%. If inflation is higher than thatas it is by the end of 2021the maximum levy will never be able to keep up with rising costs.
Let’s move on to number four. For most residences, the standard deduction is set at $45,000. Before the tax rate is applied, it is removed from the assessed value. This fixed deduction becomes less important in reducing assessed values if home prices rise rapidly. Home values would rise faster than taxable assessed values. Taxes on homeowners would grow at a greater rate than inflation.
This isn’t a monetary issue for local governments, but it could be a political issue. Homeowners are voters, and when their taxes rise, they tend to complain.
For a few years, high inflation would put a strain on local government budgets. Budgets would begin to catch up in 2023 if inflation is only temporary. Let’s hope inflation does not continue to rise.
Is there a regressive tax on inflation?
In a recent essay, Larry White discusses another time when the gross US national debt exceeded the country’s GDP: at the end of WWII. The debt-to-GDP ratio has plummeted to under 40% in only a quarter century, thanks in part to inflation induced by the central bank. While it is vital to understand this history, we must also be cautious in the lessons we draw from it.
To begin with, we will not see a similar reduction in debt-to-GDP in the next quarter-century.
Why?
Because when the war finished, the deficits did as well.
The essential point of Larry’s argument is that the debt-to-GDP ratio did not fall to only 40% because the government was generating surpluses and paying down the debt.
Because of inflation, a still-large nominal debt became a lesser proportion of a much larger GDP.
However, in comparison to what we are witnessing now, it was also an era of rapid real economic development.
Today, we face very different circumstances: population growth is significantly slower, the population is quickly aging, and the proportion of people in the labor force has dropped to its lowest level in over thirty years.
Anti-supply-side taxes and regulatory policies by the federal government and several state governments will prevent faster real growth from occurring anytime soon.
Worse, unlike at the end of the war, when the government stopped spending to add to the debt, we now have fiscal policies in place that will continue to generate enormous deficits and add to the debt for years to come.
We did not have enormous unfunded liabilities in social security and healthcare programs for seniors in 1946, but we have now.
We were at the start of several decades of declining defense spending as a percentage of GDP in 1946; now we might cut military spending to zero without improving our dire budgetary situation.
It would also be a false historical lesson to believe that central bank-created inflation had no additional negative implications.
Inflation is a regressive tax that worsens income inequality since low-income persons are more likely to rent their homes and have little long-term debt.
Inflation shifts wealth away from creditors and toward debtors.
The government, as the largest debtor, clearly benefits, but persons with major real assets, such as their homes, that are financed by fixed-rate long-term debt also benefit.
Inflation is a dishonest, divisive, and regressive type of taxing, but governments choose to use it instead of cutting spending or increasing explicit tax income to cover the level of spending.
A society that cannot or will not attain and sustain fiscal discipline will not be able to maintain monetary discipline, according to the maxim.
What is the definition of a luxury item tax?
A luxury tax is a sales tax or fee applied only on certain non-essential products or services that are only available to the wealthy.
Is this a case of indirect taxation?
Indirect taxes are usually tacked on to the cost of goods and services. Indirect taxes include sales taxes, value-added taxes, excise taxes, and customs charges.
Is inflation considered a tax?
There’s a conundrum here. Money is nothing more than a piece of paper with some writing on it. It can be printed at any time by the government. The government, on the other hand, can take these pieces of paper and exchange them for real-world goods and services. It can be used to pay soldiers, nurses, or road construction employees. It has the ability to print money, send it over to Airbus or Boeing, and purchase a new plane. So, in this instance, who is truly footing the bill?
We already have all of the information we need to figure out the solution. Prices will eventually rise as the government prints more money. When we remember that real variables are independent of the money supply in the long term, we may derive this directly from the quantity equation. The extra money will just result in higher pricing and no more output in the long term. Furthermore, as prices rise, the value of existing money decreases. If the price level rises by 10%, existing dollar bills are worth 10% less than they were before, and they will buy (approximately) 10% fewer products and services. Inflation is a tax on the money that people have in their wallets and pocketbooks right now. We do believe that there is an issue.
Why is inflation the most punishing tax?
Inflation, defined by the Federal Reserve as increases in the overall cost of goods and services over time, means that Americans will have to pay more for their necessities and other expenses than they are accustomed to.
While rising inflation can affect the value of savings accounts for those who have been able to save for a rainy day or retirement fund, rising inflation can also affect the value of savings accounts for those who have been able to practice financial prudence in building up a rainy day or retirement fund.
According to Wells Fargo Senior Economist Sarah House, many Americans were able to save throughout the pandemic due to fiscal support and the fact that COVID-19 shut down businesses and advised people to stay at home rather than spend on services they used to go out for.