Direct Inflation Tax

Economics Economics Questions
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1

Inflation acts as an indirect tax by transferring wealth to the printers of new money (central banks, government, etc). But if the capital gains tax isn’t indexed to inflation, then doesn’t that mean inflation acts as a direct tax too? In the sense that if inflation increases the nominal value of your wealth, you have to pay a tax on that increase (Capital Gains tax), so the real value of your wealth decreases. Say I’ve got $10, and inflation this year is 100%, meaning the nominal value of my money increases to $20. I have to pay 15% capital gains tax on this $10 increase, $1.5, so after tax I’m left with $18.50. Due to inflation, this $18.50 is only worth $9.25 in the previous year’s dollars, meaning the government has effectively taxed away 7.5% of my wealth. Running the numbers in excel, at 100% inflation and 15% capital gains tax, within four years the government would have taxed away over 25% of national wealth, within nine years over 50%, and within 16 years over 75%. If the capital gains tax was doubled to 30% (Buffet tax, maybe), then at 100% inflation, within 5 years half of national wealth would have been transferred to the state through ‘capital gains’ tax, and within 15 years 90% of national wealth would have been stolen in this manner.

With only 10% inflation, the wealth transfer to the state is much smaller, but still significant. With 15% capital gains tax and 10% inflation, the capital gains tax would transfer 10% of an individual’s real wealth to the state within eight years, and 20% within 16 years. This is an effective wealth tax of over 1% per year. If the capital gains tax were to be doubled to 30%, then at only 10% inflation, an individual would lose 10% of their real wealth to the state within four years, 20% within nine years, and 30% within 13 years - an effective wealth tax of over 2% per year.

America’s historical average inflation rate is apparently around 3.4%. I’ve no idea what the historical average capital gains tax is, but I’ll assume 15% for simplicity’s sake. With 3.4% inflation, and 15% capital gains tax, it takes 22 years for 10% of private sector wealth to be transferred to government. If we assume this capital gains tax existed in 1951, then in the 60 years since then just over 25% of private sector wealth has been transferred into the hands of the state solely by virtue of the Capital Gains tax not adjusting for inflation.

So my question, is this analysis correct? Has the State really stolen 25% of existing national wealth in the past 60 years, due solely to how the capital gains tax doesn’t account for inflation, or am I missing something?

2

You’re absolutely correct. One of the primary purposes of inflation is to create the very illusion you have found in the case of capital gains tax. But note that it is not limited to capital gains taxes, the damage extends all through the entire economy and regulatory system. For example, if you work for some companies, you will receive an annual “cost-of-living adjustment” of 2-3% per year. But the Bureau of Labor Statistics actively distorts the true inflation rate which probably averages much closer to 5%. If the 2-3% “cost-of-living adjustment” is a common practice among employers, this means that people who are doing their job but not receiving a promotion in a given year are actually being paid 2-3% less per year, compounded. Employers are the primary beneficiary and this is why Democrats are always hyper-ventilating about taxing business. They understand that businesses directly benefit from government policy (including inflation) and, therefore, they owe Don Corleone, err, I mean Congress for the favor.

But it doesn’t stop here. Consider the $10,000 Currency Transaction Report required by the 1986 “Anti-Money Laundering Act” (hahahaha!) - $10,000 today is the equivalent of $4,837.89 in 1986 by the BLS’s own inflation calculator (probably closer to $2,500 in 1986). Hard-and-fast numbers like the $10,000 reporting limit represent ever-falling ceilings that automatically increase the government’s control of the economy with inflation over time. The same goes for the new $600 1099 limit.

Clayton -

3

Whoa whoa…hold on there, tiger. Where did you get the extra $10? What did you do to create a capital gain? I think you’re missing a very vital point…just because each dollar you hold is worth less, it doesn’t mean you’re automatically given new dollars to make your purchasing power whole again. If that were the case, there wouldn’t be any wealth transfer taking place.

The reality is you’ve got $10, and inflation this year is 100%, meaning the purchasing power of your money is now half of what it was (provided prices dropped proportionally…which, they don’t, but this is just for illustration). But you’ve still only got $10. The nominal value of your money is still just $10 dollars. The real value of your money has dropped 50%. To maintain your purchasing power, you would need to have $20 nominal dollars. But who said you maintained your purchasing power? Where did you get that extra $10 you needed?

You’re literally describing a scenario akin to everyone’s accounts and every dollar bill in circulation magically having another zero on it. Everyone has exactly the same purchasing power they had before, it’s just that accounts and all other holdings are just nominally that much larger.

I think what Clayton is taking your assessment to be speaking of is the simple push of more people into higher tax brackets…over time. Yes, if prices continue to increase, eventually wages will increase as well, meaning people will be making more and more nominal dollars…which means they’ll qualify to be taxed at higher and higher rates. But this doesn’t happen over night. Those people have to earn those extra dollars first. They don’t just appear magically as new dollars are created. If every dollar that was printed was evenly divided and placed in everyone’s account as it was created, no one would be profiting from the inflation.

4

Say I get the $10 because I had my original $10 invested in the stock market, and there’s 100% inflation, so the value of my stocks increases to $20. But, there’s been no increase in the real value of the stocks; the increase is entirely due to inflation. I get taxed for this increase, even though it was only a nominal increase, meaning in terms of real value my wealth is decreased. You say “if every dollar that was printed was evenly divided and placed in everyone’s account as it was created, no one would be profiting from the inflation”, I’m saying no, the government would still profit, because the way these dollars are distributed into people’s accounts is through the form of interest (higher inflation means banks offer higher nominal interest rates, stocks have higher nominal returns, etc, at least in theory), and this interest is taxed by the capital gains tax, even if it’s not a real increase in value and is due entirely to inflation.

edit* What I mean is, in terms of mainstream economics, the idea is that in a perfect world we could have even 50% inflation and there wouldn’t be a wealth transfer, since all asset classes would increase in value equally, so as long as you had your money invested in something you wouldn’t lose purchasing power. Of course, Austrian economics shows this assumption to be unreasonable, and that in fact those who spend the newly printed money get the most value from it. But I’m saying, even from the viewpoint of mainstream economics, if all asset classes inflate equally, and there’s no transfer of wealth in that sense, then there is still a transfer of wealth due to the Capital Gains tax not accounting for inflation. Because the inflation of assest values occurs through the form of capital gains: in simple mainstream theory, if the real return is 3%, and inflation is 50%, then banks would be offering an interest rate of around 53%. However, this 53% is taxed as capital gains, when in fact only 3% was due to capital gains, and the 50% just due to inflation.

5

Obviously that changes things.

Yes, I addressed this. That was the whole point of the final paragraph.

I totally knew that sentence would get pulled out. I was so close to adding an exception/clarification for government being able to tax more money at the end of it, but I didn’t feel it was necessary, given that that was the entire point of the paragraph.

The bottom line is you’re making it way too complicated. We’re talking in hypotheticals. I said “IF” every dollar that was printed was evenly divided and placed in everyone’s account as it was created…that doesn’t happen. It has never happened, it will never happen. So all this talk of “the way this happens is through interest, yadda yadda yadda” is a moot point, because it doesn’t happen.

But to your point, yes, more money is taxable if more money exists, and yes, the more nominal dollars people have, the higher percentage of those dollars the government will take from them (because income tax rates are determined by nominal amounts). This is what I was describing in the final paragraph. And yes, if the dollar value of an asset increases simply due to inflation, the increase is considered capital gain, and upon sale of the asset for a higher nominal value (which may actually not be a real profit), a tax is due on that increase. Peter Schiff has talked of this for a long time in the case of precious metals like gold and silver, as increases in their nominal values can generally be accounted for through devaluation of the dollar. This is why he (and others) have made the argument to make these holdings tax exempt.

But the point is you don’t just automatically get $10 extra dollars simply because your money lost value. People aren’t automatically made whole…otherwise there would be no wealth transfer taking place (again, not counting the higher percentage of one’s income that is now made taxable, assuming nominal milestones aren’t raised.)

6

We’re talking in hypotheticals because those are the hypotheticals generally used for analysis of inflation rates in mainstream economics (general macro textbooks, etc). I’m not denying the loss of purchasing power due to inflation, but the simple models in question do deny this loss of purchasing power: they assume it can be avoided by having one’s money invested, that all asset classes will increased in nominal value directly proportional to inflation. They say, if the real rate of return on an investment (say, bank deposit) is 3%, then if inflation is zero, interest rates paid to depositors will be 3%, and if inflation is 100%, then interest rates paid to depositors will be 103%, with the same increase in real wealth resulting (3% increase), regardless of inflation. I’m saying that, even within the context of those models, which ignore most of the negative effects of inflation, a transfer of wealth still occurs, due to the capital gains tax treating that 103% interest rate as real return, when in fact only 3% is actual real return, and the other 100% is just inflation.

Take the inflation rate as I, the capital gains tax rate as T, and the starting capital as X, and assume (as the mainstream models do) a best case scenario of the inflation causing no decrease in the real value of the starting capital X, due to all nominal asset values magically rising in perfect proportion to inflation. Also assume no real return. After one year, wealth valued at X dollars will have increased in value to X+XI dollars, due to inflation. However, capital gains tax of T is levied on this increase in nominal value, meaning XI (the ‘capital gains’) is reduced by T%, hence reducing the dollar value of X by XIT, to X+XI-XIT. The ratio of X+XI-XIT to X+XI is the ratio of the reduced value of the asset (due to taxing the increase in nominal value as a capital gain, when in fact it was just inflation) to the actual value of the asset the previous year, expressed in this year’s dollars. Subtracting this from one gives the percentage of wealth taken by the tax; 1 - (X+XI-XIT)/(X+XI), which simplifies to 1 - (1+I-IT)/(1+I), or 1 - 1/(I+1) - I(1-T)/(I+1). This means that, even without accounting for any indirect effects, with a capital gains tax that doesn’t account for inflation, any inflation represents a wealth tax of at least 1 - 1/(I+1) - I(1-T)/(I+1), where T is the capital gains tax rate and I is the inflation rate. Which is to say, it’s mathematically impossible for inflation to tax wealth any less than described above, although of course through indirect effects it’s possible for the inflation tax to be far greater. This same math suggested that, assuming a 15% capital gains tax rate and 3.4% inflation, in the past 60 years the State has confiscated just over 25% of the national wealth that existed in 1951, solely by virtue of the capital gains tax not accounting for inflation (although again, when the indirect effects of inflation are included, this confiscation would of course be far greater). This seemed like quite a large number, 25%, hence why I was asking if it was correct, or if maybe I had misunderstood something about the tax code, how it’s collected, etc. Because if it’s correct, you’d think more people’d be pushing for capital gains tax reform, as it’s not hard to spot; you don’t need a capital theory or anything like that, just the historical interest rate and capital gains taxation rate statistics, and a calculator (assuming those numbers are correct and I haven’t misunderstood anything).