Inflation, the Regressive Tax

"Inflation is always and everywhere a monetary phenomenon."

Milton Friedman

Let us assume the economy has 100 dollars.  There are 10 people in the economy, each with $10.  The government levies a 20% tax.  Now, everyone has $8 and the government has $20.  Simple.

Let us suppose the government would like to spend more than $20.  The majority of the ten people in the economy don't want to pay more taxes.  Efforts to raise taxes are voted down.  What to do?

"I have an idea!" the Federal Reserve declares exuberantly.  "Let's increase the money supply."

"Won't that just reduce the value of money?"

"Yes, but government will have the money.  If we print an additional $20, we will have $40 to spend.  By the time the people realize that the money supply has expanded, we'll already have spent it."

In this simplified scenario, the citizens held 80% of the money while the government held 20%.  After the government printed another $20, the citizens now only had 67% of the money while the government had 33%.  Effectively, government has implemented a new tax rate of 33%.

Of course, the government is going to spend its newly minted money by giving it to citizens for goods, services, or entitlements.  When the inflation works out of the system, the division of the $120 economy will $12 per citizen, which will then be taxed by 20% ($2.40).  The new balance will be $9.60 per person and $24 for government.

"Gee, it was fun spending all that money," Senator Spendthrift declares.

"Quantitative easing?" The Federal Reserve suggests.

Another $30 are printed, giving the government $54 to spend.  And on and on it goes.

The thing about inflation is that it hits lower income people harder than higher income people.  If you own stocks or property, they appreciate in value.  A stock that was worth a dollar before government poured that $20 into the economy will now be worth $1.20.  After the second inflow of cash, it is worth $1.50.  This is also true of real estate.  That $100,000 home will require more devalued dollars to buy it.  Skyrocketing home prices are great for homeowners, not so great for would-be home buyers.  It is particularly bad for renters.

Bad governments love inflation.  Inflation is a tax that the populace can't avoid.  Inflation happens when the money supply grows faster than the economy.  The Fed knows what it is doing.  This is intentional.