Inflation Tax

Inflation Tax Definition:

In simple grammar inflation tax is explained as a burden imposed on the cash holders by inflation; or reduction in purchasing power by currency; i.e. if a certain quantity of good of a given quality is brought at a certain price then over a time because of inflation the same quantity of good is brought at a different price (may be higher or lower).  In other words it is the decrease in buying power on holders of currency or fixed return assets that inflation imposes. The lost of money power going to the government as it inflates the money supply.

Inflation Tax

Is a on-going increase in prices, as measured by the change in price of a basket of goods.

According to many economists the main sufferers of inflation are the lower and middle class people.

How Inflation Occurs:

When the central banks of a particular country print notes and issue credit, they increase the amount of money available in the economy. This is done to withstand to worsening economic conditions. But in the long run this increase in the amount of money causes inflation by increasing the money supply and causing the money holders to pay tax. This is nothing but the “inflation tax”. Financing of expenditure obtained in this way is called as “Seigniorage”.

Inflation reduces the net value of previous borrowing and at the same time increases the revenue from taxes.

The sum of inflation tax and seigniorage is nothing  but the change in monetary holdings or real balance.

 So real balance = seigniorage + inflation tax.

Ron Paul Inflation Tax:

According to Ron Paul , the inflation tax majorly hurts the middle-class and the poor sections. Printing money to pay for the government’s expenditure relegates the value of the currency which tends to increase the price for goods and services. Inflation levies a tax burden on those individuals who suffer most by increase in the cost of living. The spending of the government, deficits and reserves make the lower income class suffer while making the rich more richer.

Raising the taxes can be a better option for the decreasing the deficit rather than borrowing money. Another choice is to give credit to pay the bills the government runs up.

Finally, inflation tax cannot make the things better rather it worsens the conditions. Taxing the people, borrowing money from revenue sources and thus inflating for the enormous government’s expenditure cannot make a country wealthier but on the contrary it makes the country poor.

Capital Trading and Stock Trading:

A capital market is a type of market which provides securities for either company or government to raise long term funds. This includes stocks and bonds.

Here the company or the government issues bonds to the customers or the individuals who buy these bonds for given price by lending the money which he holds with him to the company or the government, for a certain period of time. The individual is assured a higher rate of returns for investing his money in their bonds.

There is another way the companies or the government can raise money. It is through stock market. The companies or the government sell shares of the stock to the ordinary people or other companies in order to raise money. These people are given dividends each year, if the company has any profits.

The capital market consists of two types of market.

  • Primary market
  • Secondary market
Primary Market:

This is market where new stocks or bonds are issued to investors.

Secondary Market:

This is market where the existing stocks or bonds are traded.

Variable Time Preference:

The time value of money shows a fact that the money held at present is more value that an identical amount of money received over a period.

Time preference can be defined as the person’s interest in two types of payments. One is the fixed payment and the other is variable time preference.

In fixed time preference the payment is made in the present without any addition or interest to the amount which he or she receives.

In variable time preference the payment is made in the near future in addition to the money which he or she invests in the present. As the percent of interest increases the individual will try to invest more and more money in the future payments in order to receive more money for the amount invested.

For example, the value which an individual gives to a tract of land or an object like gold or silver. An individual invests his money in the land in order to gain high returns in the future for the money invested in the present. This is called as variable time preference.

Public and Private Savings Inflation Tax:

In order to avoid the risk of tax paying an individual goes into savings which are in different ways. The first one is public saving where the person tends to invest his money into government concerned firms like national savings, public provident funds and savings in banks. Some of these provide tax redemption also.

The other one is private savings which involves investment into equities, bonds. In most of the public savings the inflation tax does not play an active role. When then inflation is inching up saving of money in the public savings is the best alternative. This may not give high returns but it gives safety to the money an individual has invested. This also offers attractive rates of return. For example, post office schemes like national savings certificate offer 8% to 9% returns which are guaranteed. Investment in Gold is also preferred in times where the inflation is uncertain. Because, most of the time gold is hedge against inflation.

In private investments an investor should be careful about inflation. Inflation is a biggest threat to investors. If the purchasing value of the capital given as a debt is lost by some x% every year because of inflation then the lender will try to offset this money by increasing the interest rate to the borrower. In other words he will increase this interest to maintain the buying power.