Inflation Tax - How IT Occurs

How It Occurs

When central banks print notes and issue credit, they increase the amount of money available in the economy. This is sometimes done as a reaction to worsening economic conditions. It is generally held that in the long run, an increase in the money supply causes inflation. Some have argued that, in effect, increasing the money supply and causing the holders of money to pay an inflation tax is a form of taxation.

If the annual inflation rate in the United States is 5%, one dollar will buy $1 worth of goods and services this year, but it would require $1.05 to buy the same goods or services the next year; this has the same effect as a 5% annual tax on cash holdings, ceteris paribus. Real property such as a house priced at 100k and holding steady value will sell for 105k within one year, resulting in capitol gains tax on the $5000 in "earnings".

Governments are almost always net debtors (that is, most of the time a government owes more money than others owe to it). Inflation reduces the relative value of previous borrowing, and at the same time it increases the amount of revenue from taxes. Thus it follows that a government can improve the debt-to-revenue ratio by employing inflationary measures.

However, if the government continues to sell debt, by borrowing money in exchange of debt papers, these debt papers will be affected by inflation: they will lose their value, and therefore they will become less attractive for creditors, until the government will not find any willing to buy debt.

An inflation tax does not necessarily involve debt emission. By simply emitting currency (cash), a government will induce liquidity and may trigger inflationary pressures. Taxes on consumer spending and income will then collect the extra cash from the citizens. Inflation, however, tends to cause social problems (e. g., when income increases more slowly than prices).