In Brief: The Inflation Tax Is Real
And it’s massive, hitting millions of Americans of every economic strata.
Inflation is among the biggest stories of 2021, and Paul Kupiec of the American Enterprise Institute points to an element far beyond higher prices.
If you are under the impression that the “inflation tax” is only an allusion to the shrinking impact inflation has on the purchasing power of your income and savings, you should continue reading.
Inflation is a real tax, just as real and at times nearly as important as the individual income tax. While inflation clearly does reduce the purchasing power of your earnings and fixed-income asset values, it also redistributes purchasing power from businesses and households to the federal government. And in today’s economy, with inflation running at 5.4 percent, the inflation tax is no small matter. The amount the government will collect from the inflation tax in 2021 exceeds $1.9 trillion.
Kupiec explains a bit more about inflation in the general economy before applying it to government.
The inflation tax is the amount of business and household wealth that is transferred to the federal government as a result of inflation.
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. In addition, the federal government also benefits by reducing the purchasing power of the public’s cash and liquid investments that earn near-zero interest rates.
He asks rhetorically, “How large is the inflation tax?”
First, consider what the inflation tax would be if the Federal Reserve was successful in achieving its target of 2-percent annual inflation, and inflation expectations were well-anchored at 2-percent. In this case, the inflation tax is the annual wealth transfer generated by 2 percent fully-anticipated inflation. …
Inflation expectations have been anchored at 2 percent, but actual inflation has unexpectedly spiked to 5.4 percent. The inflation tax has one component driven by the lost purchasing power of the money supply and another component generated by the impact of unanticipated inflation on U.S. Treasury debt. The tax on the money supply is approximately equal to 5.4 percent of M2 balances or about $1.1 trillion.
That leads to some staggering numbers:
To put the magnitude of this inflation tax into perspective, consider that, in 2021, the federal government expects to collect about $3.863 trillion in explicit taxes including $1.932 trillion collected through individual income taxes. With inflation currently running at 5.4 percent, inflation will transfer at least $1.9 trillion in wealth from the public to the federal government this year. I say at least because $1.9 trillion ignores the extra tax revenues inflation automatically creates in our progressive system that taxes nominal income and historical-cost-based capital gains without adjustments for the impact of inflation.
In 2021, the inflation tax will be as large if not larger than the revenues the federal government will collect from individual income taxes. The inflation tax is not only real, in 2021 it is really large.
