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I get that people seem to be using the term inflation tax as a metaphor for understanding inflation, but it seems to be a bit more than that. We all know that inflation reduces the buying power of our dollar, but I don’t see how “tax” is a useful metaphor for this notion. It would be a useful metaphor IF the goods and services we provide went to the government, but that’s only true for some. A business usually isn’t providing goods and/or services to the government, it’s usually to the general public or another business.

For the term “tax” to be used with inflation requires that the government funds their spending using inflation. But I don’t see how the government can fund their spending (effectively) using inflation.

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    You're just confusing, what is anyway a confusing discussion. You often hear it said that: "Inflation is sort of like a tax" It's just that simple. (Some people agree with that, some do not - whatever, it's a political/economic discussion.) – Fattie Jun 14 at 14:28
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    It's called "inflation tax" because the government has taken value from you (by the act of printing more money they made your money has less values), which is the same effect the other taxes do. – Matija Nalis Jun 14 at 19:19
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It's mostly semantics. Per https://en.wikipedia.org/wiki/Talk%3AInflation_tax#:~:text=An%20inflation%20tax%20is%20the,that%20subtracts%20value%20from%20currency.

An inflation tax is the economic disadvantage suffered by holders of cash and cash equivalents in one denomination of currency due to the effects of inflation, which acts as a hidden tax that subtracts value from currency.

Inflation itself is a highly complex phenomenon that is entangled with many aspects of economics, finance, and politics. "Inflation tax" is simply "the effect of inflation on cash-like investments".

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    Calling something tax is usually to evoke an emotion. – lalala Jun 15 at 16:15
  • @lalala I wonder if they'll start calling it "inflation theft" and then "inflation violence" and then "inflationcaust" if "tax" doesn't work well enough for them – user253751 Jun 17 at 11:44
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It IS going to the government. What causes inflation is when the government increase the money supply faster than the economy is growing.

Imagine a simpler monetary system with no fractional reserve banking and no electronic money. All money is paper bills. The government prints the paper bills, and then uses this paper money to buy things, thus inserting the new paper money into the economy.

So suppose that the economy of a certain place at a certain time is producing, say, 100 million unit of "stuff". There is 100 million dollars -- let's call the currency "dollars" for convenience -- in circulation. So each unit of stuff must cost $1.

Then the economy does not grow, but the government prints another $10 million of currency and uses it to buy things. What happens? There's still just 100 million units of stuff being produced. So there's now $110 million to buy 100 million unit of stuff. The price of each unit of stuff must rise to $1.10.

The government used this $10 million it printed to buy stuff. At the higher inflated prices, $10 million buys about 9 million unit of stuff. That 9 million unit of stuff would otherwise have been bought by private parties. So the government has taken 9 million units of stuff out of the 100 million, leaving only 91 million for private citizens. The government effectively taxed the people 9%. But the tax was subtle, because they didn't actually hand any currency over to the government. They paid the tax in the form of lower value for their money, i.e. an "inflation tax".

This isn't a hypothetical example. Many governments have tried to finance government programs by printing money. The result is pretty much always inflation.

Real life is more complex than my simple example. Most money today is not paper and coins but electronic entries on a computer. An increase in the money supply of X% does not necessarily result in EXACTLY X% inflation, because there's the issue of "velocity of money, that is, how many times is each dollar spent in one year. Etc. But the principle is the same.

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    "What causes inflation is when the government increase the money supply faster than the economy is growing." This is not the only source of inflation. Resource scarcity can play a role; see, for example, what happens when gas supply is impacted. – ceejayoz Jun 14 at 11:21
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    @ceejayoz You're confusing "increasing prices for some product" with "inflation". If there's a shortage of, say, gasoline, then the price of gasoline will go up relative to other products. In that case resources are diverted from other products and services. People may buy fewer movie tickets or steaks or whatever to pay for the higher gas cost. "Inflation" is when there is a general increase in prices and wages. The price of everything goes up. Of course the increase is not exactly the same for every product and service because all the factors that affect price are still operating. – Jay Jun 14 at 14:22
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    @Jay I'm not confused at all. Inflation is literally measured by measuring the prices of a group of products. An increase in the price of gas increases shipping costs on pretty much everything; thebalance.com/…. "The price of gas has swung so wildly that it’s been an important driver of changes in the overall CPI, despite making up just 3% of its “basket” of goods that government statisticians use to calculate inflation." – ceejayoz Jun 14 at 14:26
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    There's a lot wrong with this answer. In addition to the things others have mentioned, it simply isn't true that inflation always follows when the rate of money creation exceeds the rate of growth in the economy. If, for example, the private sector decides to hold larger cash balances (perhaps due to uncertainty about the future), then the money supply must expand to accommodate that change, but it won't cause inflation. – Nobody Jun 15 at 12:03
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    @Nobody I specifically mentioned the issue of the velocity of money and referred to other complicating factors. Could one imagine a scenario where the velocity of money decreases, and the government creates exactly enough additional money to compensate for this? Sure. In such a case the government action would prevent deflation rather than causing inflation. I don't know of any case where this has actually happened in the history of the world, but it's certainly theoretically possible. – Jay Jun 15 at 12:14
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I believe the best way to address monetary inflation by the government (a.k.a. money printing) is by referring to it as a "hidden tax." Taking the US as an example, over the past 100 years, prices in the US have roughly increased by 5% per annum, and the purchasing power of the dollar has also dropped by about the same amount. A fancy way of describing an increase in the US monetary base is the Fed "expanding its balance sheet."

Money printing via fractional reserve banking is an excellent way for a government to reduce its debt burden. Due to something called the Cantillon Effect, when the Fed (or any other central bank) creates new currency, it gets to enjoy the full purchasing power of that newly created currency. This currency can be used for all sorts of things, not the least of which are paying off debt obligations. Governments love the inflation tax, because they don't have to explicitly ask citizens to pay it. Instead, it happens under the covers, in stealth mode. The problems arise, again due to Cantillon Effect, when the newly printed money works its way through circulation. As that happens, prices of everything will tend to rise. By the time the printed money reaches the average person, it buys less than the equivalent amount of currency held in the hands of citizens purchased, before the central bank printed that money.

Rest assured, central banks around the world, in particular the Fed and ECB, have every intention to try to print their way out of their current debt conundrums. Only time will tell if they can do this without a loss of confidence in their currencies taking place.

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  • So would it be better to just give everyone a bit of the new money? – Paŭlo Ebermann Jun 14 at 17:44
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    @PaŭloEbermann This has kind of happened, with all the stimulus programs happening. – Michael Jun 14 at 22:13
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The "tax" in "inflation tax" is metaphorical. It means that although you have, say $100, in your bank account, your actual purchasing power is less than you would expect because of inflation. From your point of view it's as if someone came along and took a little bit of your money, like the tax man does.

It's actually quite common to use "tax" in this metaphorical way, even when the government isn't involved, and even when the resource being "taxed" isn't money. For example, if your coworker Steve is overly chatty, then you might be reluctant to ask him a short question because of the "Steve tax" of having to listen to him talk about his favorite sports team for 5 minutes before you can get out of his office. See https://en.wiktionary.org/wiki/tax, sense 2, for another example.

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  • Just so. And you may hear lotteries referred to as a "tax on gullibility" (or stupidity, or hope, etc) – Jim Mack Jun 15 at 16:04
  • also: pink tax, which is interesting in the sense that while it's largely a market arising phenomenon rather than a formally delineated, legislated tax code, there are in fact real taxes on tampons, in particular, resulting in them being non-exempt and classified as "luxury" goods; also, price discrepancies can also arise due to higher import tariffs on some products designed for women. these complicated details induce confusion in people conflating real taxes with metaphoric ones. ( e.g. "repeal the pink tax"). (not trying to make feministic arguments. this is for informative purposes only) – FluffyFlareon Jun 15 at 19:24
  • Yep, both good examples. – Nobody Jun 15 at 19:24
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Depending on the situation, inflation can actually result in a transfer of wealth to the government.

Inflation is bad for creditors and good for debtors, because while any monetary debts stay the same nominal value, the purchase power those debts represent decreases.

So when a government has a high amount of debt, then intentionally causing an inflation can be a way to reduce the purchase power of that debt. Which means that there is a net transfer of wealth to the government.

This is most obvious with those citizens who invested into government bonds, and will now receive a coupon which represents less purchase power than they invested.

But it is also indirectly the case with citizens who have their money in a regular bank account. Sure, you might think you are losing money to the bank, because they now owe you less wealth if you decide to withdraw your money. But where does the bank gets its money from? The central bank, which is run by the government. So indirectly you are losing that wealth to the government.

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