Legal-Ease An Attorney’s Perspective: What Is Inflation Tax?

Judd Matsunaga

Let’s say you have a group of people, and these people buy things. Under Scenario 1, let’s assume they earn $50,000/year, and the price of a Big Mac Meal from McDonald’s, shoes from Target and a tank of gas are $5, $30 and $50, respectively. And in buying these things, they give these businesses money. In return, they receive goods and services from these businesses, i.e., a Big Mac Meal, shoes and a tank of gas.

Now, if the government were to print enough money to double the money supply, we would have twice as many dollar bills floating around — but the same amount of goods and services. All that would happen would be that the prices of these goods and services themselves would double. So, a Big Mac Meal goes from a price of $5 to a price of $10, the tank of gas goes from a price of $50 to a price of $100.

And, of course, one of the prices that would double are people’s wages. So now, in Scenario 2, you’re earning twice as much as you were before, $100,000/year. But the prices of the things you buy have all doubled as well. So, if I were to ask you are you better off in Scenario 1 or Scenario 2, the answer is you’re the same in both. It doesn’t matter to you whether you’re earning $50,000/year and a tank of gas costs $50 or whether you’re earning $100,000/year and gas costs $100 — it’s the same amount of gas.

However, there should be a significant difference in the two scenarios, and the difference shows up when you look at your savings. Let’s suppose in Scenario 1, you had $200,000 in savings, you’re earning $50,000/year and a Big Mac Meal costs $5. Along comes the government, it prints enough money so all the prices double. That means that the Big Mac Meal costs twice as much, the shoes cost twice as much and you’re earning twice as much, but your savings is the same. It’s the same $200,000 sitting in your savings but only buys half (50%) of what it used to.

This is what happens when the government comes along and prints lots of money. In effect, what it’s doing is draining away the purchasing power of your savings, i.e., inflation is a tax on your savings. When the government prints money and thereby creates inflation, we get the same exact effect as if the government had imposed a tax on people’s savings. So, economists say it’s called an “inflation tax.”

Sound familiar? Beginning under then-President Donald Trump and continuing through President Joe Biden’s administration, Congress has approved some $4.5 trillion in Covid relief funding, according to CNBC (Dec. 9, 2021). One trillion is 1,000 billion or a million million — it’s a huge amount of money. A trillion is a 1 followed by 12 zeros, like this: 1,000,000,000,000.

The government benefits from inflation by paying off debt with cheaper dollars each year. Because inflation raises wages as well as prices (but wages almost always rise more slowly than prices), tax revenues increase. This gives more income to the government, which allows it to increase its debt and debt payments.

And just like our Scenario 2, the cost of food is going up. According to the Wall Street Journal (Dec. 27, 2021) food prices are estimated to rise 5% in the first half of 2022, while other sources point to a 7% increase by the end of the year. This number might be even higher if we consider that many products are also shrinking in size, which means you’re getting less for more.

Gas prices are also at record highs. Experts fear the conflict between Russia and Ukraine could disrupt oil supplies in the region, which would lead to a bump in gas prices. Russia is the second-largest oil producer in the world behind the U.S. Experts project much of the U.S. could see gas prices go up as high as $4 by early spring, and markets like California and Hawaii – where gas is already expensive – could top $5 (source: USA Today, Feb. 23, 2022).

Not surprisingly, inflation has hit a new 40-year high in January. Inflation surged 7.5% annually in January, surpassing the previous 40-year high set in December and marking the highest annual inflation rate since February 1982, when it was 7.6%. Inflation is rising at the fastest pace in decades, which means consumers are paying more for rent, utilities and groceries than ever before.

Financial institutions such as banks love inflation because the new money created to finance government debt goes to them as loans from the Fed. Because big banks are flush with cash and do not need to raise rates quickly to attract more deposits, the average rate paid on basic savings accounts insured by the Federal Deposit Insurance Corp. is just 0.06%, according to Bankrate.

They, in turn, lend this money to consumers at a much higher rate of interest. Mortgage rates are going up, approaching 4%, and auto loans are approaching 6%. Obscene profits are possible if one borrows at, say, 1% interest or less and then turns around and lends that new money to a consumer who must pay 4%-6% interest.