Inflation a Hidden TaxTaxation is a hotbed topic, and for good reason. The amount of taxes that the government levies on citizens can have a major impact on the economy. No one can seem to agree on the best balance of taxing and spending. In can be argued though those proponents for tax increases might be getting their wishes fulfilled through monetary inflation. Monetary Inflation is one form of tax that seems to slip completely under the radar. Monetary inflation is the worst tax of all, because it ultimately lowers the spending value of your money, just as if it had been taken right out of your pocket without any news laws or any up or down vote in Congress. Consequently, you have to spend more for the goods and services you need or want.

Understanding Inflation

In order to understand why monetary inflation is like a tax, you need to understand what it is. When you hear the word “inflation”, most people think of higher prices or price inflation. In the common usage of the word “inflation,” it does mean rising prices. While price inflation is the end result, the actual cause in most cases is monetary inflation. Fundamentally, monetary inflation means that there has been an increase in the money supply, and the increase in dollars means that there is more money competing for the same amount of goods and services in the economy. This creates artificial demand, which drives up prices.

Here are a few ways the money supply gets increased in America:

  1. The Federal Reserve lowers interest rates
  2. The Federal Reserve prints money. This happens because it purchases IOUs from the treasury with money printed out of thin air

When the Federal Reserve lowers interest rates, the cost of borrowing money becomes cheaper so that individuals and businesses – with more money at their disposal – are more likely to borrow money and to go out and spend. This seems like a good idea, because it stimulates the economy, but this is not always the best method because it leads to a misallocation of resources. The influx of money into the economy means higher demand and therefore higher prices and a decreased value of the dollar. In addition, people spend that borrowed money on things they can’t necessarily afford, and businesses expand when they may not have the business to warrant it. This creates a bubble that will eventually pop – like with the recent mortgage crisis (with many saying the bond market is next).

When it comes to printing more money, this also seems like a simple solution. The government needs more money to spend on its programs, so in a few different ways it creates money (with the help of the Federal Reserve). However, generally this money does not get redistributed to the people evenly or equitably; it generally stays in the government’s coffers to fulfill their own agenda and special interests. Therefore, the average person does not benefit from this additional money, but the value of the dollars they already have has dropped because of the increase in supply. Think of it this way: if you water down your shampoo, it doesn’t work as well, so you have to use more of it to do the same job. You end up spending more on shampoo as a result, lowering the buying power of your shampoo dollars.

Recently, one way the money supply has been increasing substantially is through “Quantitative Easing.” Basically, the government needs more money so the Treasury issues more IOUs. Foreign central banks purchase these IOUS or government bonds along with companies called primary dealers (private companies). Primary dealers then sell a portion of these bonds (along with other private financial assets) to the Federal Reserve (in the US the Federal Reserve cannot purchase US government bonds directly from the treasury). But where does the Federal Reserve get this money? It creates it out of thin air.

Why Inflation is a Sneaky Tax

Because the increased money supply devalues the dollar, the dollars you have are worth less – they have less spending power. It’s almost as if money was taken right out of your pocket, only you didn’t declare it on your tax return and there’s no accounting for it on your paycheck. Yes, very sneaky.

The problem with all of this is not only the devaluation of the dollar, but also that it sneaks up on us without our knowledge or approval. While we vote on most tax increases, we little or no control over inflation. The best thing that we can do is to spend our money wisely and not over-extend ourselves.

So Are “Tax the Rich” Proponents Winning?

Not entirely. While many tax increase proponents want higher taxes levied on the rich, the end result from inflation is that everyone pays more taxes — so as a result you can say yes that the rich are paying more. The biggest problem with this is that even the poor and middle class have to spend more on goods and services.