Friday, September 04, 2015

Accounting for Inflation as a Tax

I will say it again for the cheap seats, it doesn't matter how much money a country has.  It's how much stuff it can produce.  This is the beginning lesson I would always start my economics class with because not only does it simplify economics incredibly well, but it's true.  It is the stuff your country produces that determines its economic success, not the amount of money it prints.

However, an interesting, but simple thought crossed my mind.  Why haven't we ever incorporated inflation into the federal tax rate?  The money IS controlled by the government/fed and since stuff is the only thing that matters then inflation SHOULD DEFINITELY be considered when attempting to calculate one's level of taxation.

Of course we need to define things (so leftists can disagree with semantics instead of grow a spine and deal with the argument) but I think you'll find the results interesting and of course enraging.

First the TRUEST measure of the overall tax rate of a country is taking TOTAL government spending at ALL levels of government (state, federal and local) and then dividing it by the country's total economic production, GDP.  Now leftists will argument it should be REVENUE as a percent of GDP because people don't pay the full effective rate at which governments spend.  We borrow money from other people and in running these deficits we provide an effective lower rate of taxation.

Which is true....for now.

Because in the end that debt has to be paid back with either:

1.  Future taxation or
2.  Printing off money/inflated away (which again is nothing more than indirect taxation)

So true and intellectually honest economists look at what has to be paid, now and into the future, to see what the real rate of taxation is.

Second, there is not a lot of data about total government spending (including both federal, state and local) that goes back significantly to provide a decent historical look. Ergo, I used only federal data which goes back to 1960.  Still, if you want to be ever so rough about it, tack on another 15% GDP for state and local (47% for California and New York) and you'll get a rough proxy of total tax rates when we include the diluting effects of inflation on our currency.

Finally, what is "inflation?"  If you're a Keynesian you (once again) stumble over yourself to cite the CPI.  But if you're a technical person you would look at the money supply as any increase in the numbers of dollars, by definition dilutes those already in currency lessening their purchasing power (arguments about what is sitting in banks vaults as capital and not currently in circulation in the larger economy duly noted).

Regardless, when you do the math looking at the annual increase in the M2 money supply (orange) and add it on top of the federal tax rate as a percentage of GDP (blue) the results are quite interesting.

When "inflation is considered you can see it is at times a VERY significant tax, sometimes being even more costly that state/local taxes.  The oil embargo/inflation days of the 70's and early 80's are very noticeable as well as the jump in the money supply during the financial crisis.  And when you tack on the roughly 15% state and local tax, you're looking at a total government take of about 42%-45%.

Thankfully, the inflation tax (like debt) is a deferred tax that future generations will get to deal with.  The US is once again VERY lucky to be the world's reserve currency and we're also very lucky that pretty much any other significantly sized economy is in worse shape that we are.  This makes the US dollar a "safe haven" for people who are not so much worried about the value of a dollar, but just want a currency perceived to be more stable than their own.  This effectively "ships" US dollars overseas where they can no longer cause inflation in our domestic economy and why is your Apple product still costs as cheap as it does.

But don't worry, either through future taxation or inflation, the aforementioned rates above WILL be paid, and quadruply so by future generations who were nearly completely innocent.


Anonymous said...

An additional point that you might touch on that I still do not really understand is: When doing income/valuation projections, the appreciation of assets is taken into account but inflation is not. It would seem intuitive that these two would roughly cancel each other out. I think it has to do with the anticipated increase in purchasing power of a unit of currency due to general increases in efficiency across all sectors. A while since I have thought about it though, so I could be talking through my hat and it may be different in the States.

coolstud said...

More than 3,000 former Corinthian College students will have their college loans erased, the first wave of debt relief tied to the collapse of the for-profit higher education chain. The potential cost to taxpayers if all Corinthian students seek relief: $3.2 billion. heres a link that you will piss you off and I will enjoy the decline.

Anonymous said...

In a market economy production is the hostage of demand.

Why should the capitalists produce if the masses are too poor to purchase this production ? You produce to meet demand.

A country cannot produce much stuff if the consumers cannot buy it.

Inflation is an increase in the money supply. --Murray N. Rothbard

Before you single out the FED, know that the biggest source of inflation is fractional reserve banking and consumer credit. The principle that the bank can loan 9 times more than the deposits. In times of economic growth inflation is catastrophically high.

Right now, toxic assets are protecting us from inflation, banks are more stingy and are sitting on the FED's Quantitative Easings to offset the toxic assets.

Mass poverty in the USA and in the western world is protecting us from inflation. People are saving more, borrow less and cannot spend what they don't have.

Plus, the Saudis are printing oil which effectively turns the US dollar into an oil standard. I suspect that the Saudis are so invested in the US economy that they have more wealth in dollar denominated assets than they have in crude oil reserves. I suspect that their oil dumping is a move to protect their dollar denominated assets and not intended to compete against the shale oil.

Inflation will come back to devour us when the economy takes off again. Unless a cheap and abundant source of energy is discovered and massively applied to the market, the next boom will lead to hyperinflation.

The USA has every incentives to flood the markets with oil, including Iranian and Russian oil, in order to protect the value of the US dollar.

Cheap energy means that producing and distributing stuff is cheap and therefore the dollar can buy more stuff and has a high value despite quantitative easings.

Saudi flooding and soon Iranian flooding and Russian flooding is absolutely necessary to avoid a hyperinflation of the US dollar.

The USA will have to realize that they need Russian oil more than they can imagine. They cannot sanction Russia nor Iran into not selling their oil, the value of the US dollar depends on it.

Millie said...

Yes, inflation is a tax, but you forgot to discuss what it is a tax on, and that is savings. If you have a negative net worth, then inflation is is actually income redistribution to you. Not that I would recommend living life with negative net worth, since that comes with its own costs, but if you can get someone to lend you money for less than inflation, score.

brian said...

You mention Apple's off-shore cash deposits. Can you elaborate on what the impact on our economy would be if they were to decide to repatriate all of that cash at once?

I understand that in the current environment it would result in a windfall for Uncle Sam. But unloading all that cash into the US economy would have to have some impact, no?

chief renzo said...

You must have a decimal place wrong. 3.2 billion divided by 3000 students is over 1 million per student. I don't think college is that expensive yet.

Anonymous said...

@Chief Renzo,

Maybe worthless college is that expensive. Maybe $1 Million per student is the opportunity cost to the economy as a whole for worthless degrees, under employment and lack of GDP growth due to struggling with student debt etc.

Perhaps Mike Rowe is on to something about trade school. This would put people to work directly so they could save and then go back to university later on in a STEM degree.

For example, right after high school you could go to trade school and become an electrician. Then go to work and earn money. You save the money as you gain experience as an electrician and climb up the employment ladder and earn a higher pay.

You study math and electrical science at home on the evening after a day's work. A decade later you have savings and you go to university to earn a degree in electrical engineering. You come out with your degree at age 35 with no debt and a house fully paid.

By then, employers take you seriously and you can start working as an electrical engineer. At 40 you start your own electrical engineering consulting business etc.

Aaron Clarey did both, study full time and work full time. I would not have done that. I would have gone to trade school, then work full time and save and then go back to school full time.

If you're not going to be taken seriously before 35, you might as well go to trade school and work as a tradesman from 19 to 30. Then from 30 to 35 you earn a university stem degree. And then at 35 you can start a new career.