The inflation tax

With all the idle campaign rhetoric surrounding millionaire taxes and wealth taxes (read that wealth tax article, by the way, it's a good one), you might have missed the massive tax increase that was passed last week without any fanfare at all. Oh, you did miss it? Don't worry, I've got your back.

The Federal Reserve took the historic step on Wednesday of setting an inflation target, a victory for Chairman Ben Bernanke that brings the Fed in line with many of the world's other major central banks.

The U.S. central bank, in its first ever "longer-run goals and policy strategy" statement, said an inflation rate of 2 percent best aligned with its congressionally mandated goals of price stability and full employment.

First of all, generally speaking, anything that can be considered "a victory for Chairman Ben Bernanke" should also be recognized as a loss for working Americans. Furthermore, the article's nonchalant assertion that inflation targeting is okay because it "brings the Fed in line with many of the world's other major central banks" is offensive, in a "if all your friends jumped off the Brooklyn Bridge, would you do it too?" kind of way. We've all seen the mess that Europe has created for itself, and so far we've comforted ourselves by nodding in agreement that "things are different here". Nope. Not anymore. Ben Bernanke just dealt the final death blow to "American exceptionalism".

But all that aside, what comparatively few people recognize is that inflation--especially inflation as an explicitly defined policy goal--is effectively a tax levied without Congressional approval. By decreasing the purchasing power of the dollars that people earn, we're essentially confiscating a larger chunk of their earnings--that's no different from doing so more directly via taxation, and the same parties benefit from the policy in the end.

Sure, 2% a year may not sound like much to us, but it's a hell of a lot over the course of a working lifetime--with compounding, 2% annually over a 45-year time horizon amounts to a 144% increase in prices. A loaf of bread that costs 3 bucks today, then, would be expected to cost $7.32 in 2057, when today's college graduates (not to mention those who didn't go to college, screw them, right?) would be looking to retire. That's a pretty big failure with regards to the "price stability" half of the Fed's famous dual mandate.

Of course, this cost inflation isn't as big of a deal for those of us with investable assets who have a realistic method of hedging against cost increases. But it's definitely a huge problem for the poorest Americans, who live paycheck to paycheck and for whom a 2% shift one way or the other can make or break a budget. And if you think those workers' wages are likely to increase in order to keep pace with inflation, you're insane--they'll be lucky to increase at 1% a year, even if their productivity increases measurably.

Inflation, effectively, is the ultimate regressive tax. We fund our deficits and debt by printing money, and the effects of that money printing disproportionately impact the poor. I've discussed this dynamic at length before, but it's vital to remember that the way we calculate our "inflation rate"--as a one-size-fits-all statistic that includes prices of electronics, food, gas, housing, insurance, clothing, and more, and assumes that all consumers have the same relative breakdown between those expense categories--in incredibly flawed in practice.

This chart (an old favorite) shows that the poorest 20% of Americans spend nearly 60% of their income on food and energy, while the richest 20% spend only about 10%. This disparity matters significantly, as it means that different people will be experiencing different "effective" inflation rates, regardless of what the Fed's catch-all measurement declares. Without getting too deep into the mathematical weeds, it should be clear that an environment in which electronics and housing prices are decreasing and food and energy prices are skyrocketing (which is our current reality) will devastate a poor American, be roughly neutral to an "average" American, and matter little to a rich American.

It's not at all unreasonable to assert that a poor person's effective inflation rate could be closer to 3% or 4% (or higher--in developing nations, a disparity of 3% between rich and poor is not uncommon), as opposed to the summary "2%" statistic that the Fed is targeting. Too bad, then, that the poor person has no investable assets with which to hedge against those price increases.

In every way, inflation is a regressive tax that devastates the poor and working class to the benefit of the richest. Not only do the poor have no way to protect themselves against inflation, they also have the distinction of having a higher-than-average "effective" inflation rate. Sucks, huh?

If you want to know why income and wealth inequality is at such lofty levels in the United States, don't blame "capitalism" or our education system or any of a million social dynamics that politicians try to hide behind. Inflation--persistent, intentional inflation--is what keeps the lower class down, and somebody needs to tell them that. This crap has to stop some time. 

[Reuters]