The Inflation Tax

When I started my first newsletter on legal methods of tax avoidance, my focus was on income taxes. But a few years later, the U.S. economy was experiencing double digit inflation. Somewhere during that period I discovered what I chose to call the "inflation tax".

While I agree with those who argue that inflation is a tax, I don't agree that it is a hidden tax. When inflation rates get into the double digits, everyone is acutely aware of how inflation is hurting their purchasing power.

But there is an aspect of inflation that is hidden and few people are aware of it.

First, let me make it clear that I agree with the economists who argue that inflation is a function of an expansion of the money supply when the Federal Reserve buys government debt by issuing new money. There are other elements in the equation -- such as the so-called multiplier effect and the velocity of money -- but the driving force is new money created by the Fed.

The new money drives up the price of both assets and the price of nearly all products and services.

The assets and products and services aren't worth more. it just requires more dollars to buy something.

With respect to assets like stocks, real estate, natural resources, foreign currencies, collectibles, precious metals and most tangible assets, the increase in the dollar price of those assets is deemed to be a gain by the tax law. If the asset is sold, the increase in the price from when it was acquired and when it was sold is taxable. Under current law the tax might be 15% of the gain, plus state income taxes of up to 10%. Some types of assets like collectibles are taxed at a 28% federal rate and a state tax rate of up to 10%.

Suppose you bought some stocks in a company that produces oil. The stock cost $100 per share. With 6% inflation, it would double in about 12 years assuming that there is no change in the profitability of the company. Although the price has doubled, the original $100 will only buy half as many goods or services. This is like a 50% tax on the stock shares. Then, when the stock is sold, the tax law treats the increase in the dollar price as a gain and subjects that $100 to an income tax of up to 15% federal and up to 10% for some states.

So that's a tax on a tax. And it's what I call the "inflation tax".

Vern