The Insidious Inflation Tax
As the populace pays significantly more for the same necessities today versus yesterday, the question pops as to whether inflation has a benefit for anyone.
Today we’ll take a quick look at the answer – and the pain involved in accomplishing that benefit.
The answer is quite simple: our government. Not us; our government.
We all know that inflation decreases the value of today’s money and the future value of money. It’s worth less.
But it allows our government to decrease the value of its burgeoning debt. The United States dollar, as the world’s reserve currency, gives the United States a unique temptation to use inflation to minimize the value of current debt. In a Catch 22 scenario, it’s also a temptation to increase it.
Inflation really is a tax. And the longer the government allows it to happen – or feeds it by spending even more that it doesn’t have – aka, printing more money – the greater the tax we the people pay. No, it isn’t ‘voted in’ taxation. It’s an insidious way of increasing the tax everyone pays without a vote to do so.
The inflation tax is the amount of business and household wealth that is transferred to the federal government as a result of inflation.
And, because the federal government is a massive borrower, unexpected inflation causes a large transfer of wealth to the federal government from the households and businesses that provide it credit, i.e., buying treasuries. While rising, newly issued treasuries now pay significantly less in interest than the inflation rate. That can’t last. In addition, any pay raises tied to the CPI means the increased pay results in more income tax. The government wins on both counts while the working, ‘providing for the family’ populace loses.
A well-functioning financial market without undue central bank intervention will tend to set nominal interest rates equal to the real interest rate creditors require to lend plus the expected inflation rate (the so-called Fisher Effect). The more inflation, the more lenders require in interest.
The Federal Reserves’ monetary policy can also play a key role in the magnitude of the ‘inflation tax.’ When central banks are pursuing aggressively stimulative monetary policies as they are today, nominal interest rates can be artificially depressed below levels that creditors would normally require in a market without central bank interventions. In such instances, nominal interest rates may not adequately compensate investors for expected inflation.
With inflation spiking to 6.2 percent in 2021 (so far), the inflation tax will result in an estimated $1.875 trillion of purchasing power transfer from businesses and households to the federal government.
If the President and/or the Congress were focused on the negative economic impact inflation is having on households and businesses, they would lower the tax rates to at least partially offset the loss of purchasing power and wealth transfers to the government by the general public. Instead, we see the WH and Congress spending even more with what they’re calling a “reconciliation infrastructure” bill and attempting to pass a “build back better” bill – supposedly paying for it by increasing the direct tax rates (selling it as a “fair share”) which will lower the purchasing power of households and businesses even more.
The two bills mentioned – totaling nearly $5T+ – are on top of a budget that is already over a half a trillion in deficit. Our governmental representatives are obviously not interested in – or oblivious to – the inflation rate because the politicos are exacerbating it. There’s no compassion for the poor that must pay more for basic necessities. There’s no interest in keeping the middle class in the middle. Tax the rich? Inflation has everybody paying more for less. The band plays on while everybody loses.
The Federal Reserve has been buying treasury bills itself (they call it quantitative easing) – trying to keep the interest rates on treasuries artificially low. It’s also been buying gobs of mortgages from Fannie Mae and Freddie. Neat trick – the government buying its own debt with money out of thin air. Currently the Fed owns nearly $6T in government debt. After taking into account the additional $6T the government owes the Social Security and Medicare Trust Funds, only about 60% ($16T) of the government’s debt is owned by the public. $6T of that is owned by foreign countries – and of that, Japan owns $1.3T and China has $1.1T.
It’s a house of cards, folks. And nobody is doing anything about it.
Our Federal Reserve Bank is in the proverbial corner. Its job is to stimulate a slowing economy by lowering key interest rates, and slow down an overheated, inflationary economy by raising interest rates.
But here we are nearing the end of 2021, with historically low interest rates which are meant to stimulate an economy that is slowing down. But our economy is slowing down with the low rates in place while at the same time inflation is flaring up all over the place. But if it raises interest rates now it to fight inflation it slows down the economy even more.
Many call it being between a rock and a hard place. Economists call it stagflation – a term they hate to say out loud much less observe it. It’s like a curse – because there’s no good, easy way out of it.
The normal Fed responses to the two major components of stagflation—recession amid inflation—are diametrically opposed. Our Federal Reserve has left itself no tool to fix either without making the other worse.
Meanwhile, ‘we the proletariat’ pay increased, insidious inflation taxes.
There’s only one way out of this mess. It requires coordination. The Federal Reserve must raise interest rates sooner than later – and Congress needs to stimulate a slowing economy by opening up US oil and gas production and cutting taxes – or least not raising them – and stop spending even more money.
Don’t hold your breath. The political tea leaves say it will get worse before it gets better.
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Have a great and prosperous week.
Hug somebody.
References:
https://understandingdeeppolitics.org/peter-schiff-inflation-is-really-a-tax/
https://fred.stlouisfed.org/series/FDHBFRBN
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