Throughout his career, famed economist Milton Friedman described inflation as “implicit tax”. He warned that when prices continue to rise, it erodes consumers’ purchasing power, forcing them to make more money (and pay more taxes) to maintain the same lifestyle. On top of that, increases in nominal wages and incomes during periods of high inflation can end up pushing a group of hapless consumers and businesses into higher tax brackets even as their purchasing power decreases—an effect known as “bracket creep.” Change”.
“Inflation is an unrepresentative form of taxation. It is a tax that can be levied without the authorities legislating it or hiring additional tax collectors,” Friedman wrote in a 1974 article. . ” article The bill requires tax brackets to be indexed to prevent “bracket creep.”
This so-called “income tax” character of inflation makes it extremely unpopular with the public.As Richmond Fed President Tom Barkin explained in a recent report interview and CNN:
“One thing I hear clearly from everyone is that they hate inflation. They think inflation is unfair. You get a raise, and then you have to spend your raise at the pump,” he said. “It’s frankly exhausting.”
But now, new research is adding new color to the widely held belief that inflation has only negative consequences.In a new working paper titled “Is there really an inflation tax?” Edward Nathan Wolff, an economist at New York University and an expert on inequality Nearly 40 years of research Named after him, it provides a detailed analysis of the impact of inflation on Americans’ overall wealth from 1983 to 2019.
What’s his answer? “Inflation taxes” do exist, but they are not suitable for everyone. America’s middle class and top 1% have actually benefited from periods of high inflation in recent decades. “As to the question of whether there really is a net inflation tax, the answer is that it only applies to certain groups,” Wolf wrote.
A ‘tax’ to fight inequality
in his PaperIn a report released this month by the National Bureau of Economic Research, the official arbiter of the business cycle, Wolf took a closer look at data from the Consumer Price Index and the Federal Reserve’s Survey of Consumer Finances (SCF) to measure consumer income and overall Changes in wealth during periods of sustained inflation.
The economist is a member of the editorial board of The Economist magazine. Journal of Economic Inequality and Income and Wealth Review, found that while there is certainly an “inflation tax” on consumer income (measured as the difference between nominal and real income growth), there is another, more positive side to inflation. (Wolf’s books on inequality include 2015’s Inheriting wealth in America: Boom or bust ahead? and 2017 America’s Centennial Wealth.)
Inflation can lead to sharp increases in asset prices, especially real estate prices, while reducing the real debt burden of some consumers. Wolf said this means that groups of households that are lucky enough to have large amounts of assets or debt relative to their incomes – such as the “housing poor” or super-rich recent homebuyers – have historically seen declines due to inflation. To the substantial increase in family wealth. explained.
“In terms of household well-being, inflation is a net benefit to the middle class. Those in the top one percent of the wealth distribution also benefit handsomely from inflation. On the other hand, poor households (wealth rank The bottom two quintiles of households) are being hit by inflation,” he wrote.
Wolf compared the difference between inflation’s erosion of income and its increase in wealth, calculating the “net inflation benefit,” or NIG, for every income bracket in the United States.
Between 1983 and 2019, the “solid” NIG of the richest 1% of Americans was $63,500, or 6.9% of their average annual income. However, for those who are only very wealthy but below the 1%, the situation is different.
Those in the 95th to 99th percentile have a much lower wealth-to-income ratio, resulting in a NIG of -$56,200, or 18 percent of average income. The NIG is also negative for Americans with wealth between 80% and 95%.
However, for the middle and upper classes, the opposite is true. Americans in the 60th to 80th percentile of wealth (which today means a household net worth of approximately $200,000 to $550,000) tend to invest a significant portion of their wealth in real estate. As a result, for this group, inflation brought NIG to $12,700, or 16% of their average annual income between 1983 and 2019. Essentially, inflation erodes these consumers’ mortgage payments and inflates their assets enough to make up for the loss in income from having to pay more for other goods and services.
The boost is greater for middle-class households, or those in the 40th to 60th percentile in wealth. This group’s NIG is close to $40,000, or two-thirds of their annual income. “In fact, in terms of balance sheets, inflation is a boon to the middle class,” Wolf wrote of the findings.
Yet for those in the bottom two quintiles of the wealth distribution, inflation remains a nightmare. Wolfe found that this group’s NIG was -$19,300, nearly half their average income. “It is clear that poor households are particularly hard hit by inflation,” he wrote.
Wolf said his findings raise a pressing question: “Why is the public, especially the middle class, so opposed to inflation?”
His answer was that consumers often feel the psychological impact of inflation eating into their incomes, but they often “fail to realize” the generally positive impact inflation can have on their assets and debts. It’s easy to see price increases when you go to the grocery store or fill up at the gas station, but for many consumers, the positive wealth effects of inflation lowering the real cost of a mortgage over a lifetime are less obvious.
However, the Great Recession, the pandemic, and the dot-com bubble all helped Over the past few decades, more Americans have been pushed out of the middle class, at least in terms of income. According to data from the Pew Research Center, between 1971 and 2021, the number of Americans living in “middle income” fell from 61% to 50% analyze.The hollowing out of the middle class is partly due to a 7-point increase in the “high-income” category, but the number of lower- and middle-income Americans has also increased by 5 points, and many have accuse the result of inflation. What Wolf failed to mention is that inflation is deeply unpopular because hidden taxes are affecting more Americans who miss out on joining the middle class.
Should the Fed set a higher inflation target?
Overall, Wolf’s findings suggest that lower inflation protects poorer households but also hurts the middle class, thus (ironically) increasing overall wealth inequality. This has implications for federal policy and suggests that instead of the Fed’s 2% long-term inflation target, it may make more sense to set a slightly higher overall inflation target. Of course, for the poorest Americans, higher rates bring their own problems.
To combat the negative effects of inflation on the poor, Wolf proposes an interesting solution: the inflation tax credit. He argued that the IRS should calculate the previous year’s inflation rate and then use that number to “revise the tax code” and provide incentives to those most affected by rising prices.
“Shifting this tax credit across the income distribution could reduce the burden of inflation on poor households while still allowing middle-income households to reap its benefits,” he wrote.
Svlook
