Series on tax: Part 8, inflation and tax

Matt Nolan finished his series of posts on tax by discussing “inflation tax” on interest.co.nz (Infometrics version here).

The article covers a lot of ground, discussing monetary policy, “one-off” money financing, and seigniorage.  These areas are all related, but all involve special elements.

The key point on money financing is the ability to “commit” in order to have policy choices that are consistent with the expectations of individuals.  Money financing and the such involves trying to trick people, when monetary policy is appropriately set.  This both breaks the government’s ability to commit (by undermining the central bank they have given independence to “tie the governments hands behind its back”) and hurts people that were tricked!  In this way, such a tax works like the other taxes we’ve discussed … just with added costs.

In terms of seigniorage the key point was that it is those unable to protect themselves from inflation that end up paying (those holding assets with fixed interest rates/payments, those that have retired, those with fixed incomes etc) – and with interest rates on call accounts becoming more prevalent the ability to earn seigniorage revenue is falling.  One advantage Matt forgot to mention as he panicked about making it too long is that seigniorage acts as a tax on “black market” transactions – this was an unfortunate oversight in his article, given it is an important point.

Concluding the series, Matt noted:

No matter how much people talk about money, interest rates, inflation, and exchange rates these things only truly matter in terms of real goods and services.

The lens of taxation helps us to understand how different government policy influence the distribution of these goods and services, and the incentives people face to produce these goods and services.

The tax framework allows us to think about trade-offs.  If we try to stand back from judging certain outcomes as bad or good for a moment, it can provide a powerful device for trying to describe what may happen if policy was to change – but it also indicates how complicated the changes can be!