After Tax: An end to inflation is a real tax break

Some of the most cheering advertisements around these days are Wal-Mart's. Its campaigns feature "rollbacks", price reductions the retailer is offering consumers. Yesterday, for example, I decided I could afford a present for a child when I read on Wal-Mart's website: "We've rolled back the price on My First LeapPad, the '2001 Best Educational Toy of the Year.'"

The Ikea catalogue engenders similar good feelings. It is reassuring to know, for example, that you don't have to rush out to the furniture warehouse emporium and pick up that desk today. The catalogue routinely announces its prices will stand for a good few months.

Then there are those wonderful no-interest cars Detroit has been offering. And the possibility for home re-finance that existed this past winter.

I write about these things because they are a sort of silent reminder of what's good about our nerve-racking, volatile economy. The federal tax code may not be offering us too many serious breaks these days, but cheaper prices feel like a tax break all their own. And they are a tax break, a break from the old tax of inflation.

It's important to remember that it wasn't always thus. Back in the 1970s, lawmakers did not have to raise a finger when they wanted to pull in some more revenue. Inflation did their work for them. These days we find ourselves in higher brackets after we get a promotion or a bonus at work. That's so-called "real bracket creep". But in the old days we had the genuine article, inflationary bracket creep. Taxpayers were seeing the purchasing power of their money decrease. But because brackets were not indexed, and taxpayers' pot of nominal dollars were growing, they landed in higher and higher brackets.

This engendered bad feeling, to say the least, among taxpayers. Some were analytic about the problem. Back in 1981, reader Francis Gaffney interpreted his, and the nation's, situation in the New York Times: "Over the past 10 years a result of high inflation and our graduated tax rate structure is that tax revenues have increased at a much faster pace than the inflationary spiral."

Most taxpayers weren't so articulate. They were just angry. In The Worst Tax?,a book about the property tax, author Glenn Fisher reports a homeowner's reaction to a 250 per cent property tax increase that resulted, in part, from inflation. "I forgot all about where I was and what I was doing, and fixed, like tunnel vision, on the bill. Inside I got hysterical - I was filled with fear and also anger, and it was such a mix of emotions that I just stood there, and I think I vibrated for about ten minutes."

Part of the problem in those days, and to some degree a problem still today, is that inflation is one of the hardest economic phenomena to understand and stop. In those days, many economists believed there was a trade-off between inflation and unemployment. They based their argument on the work of A.W.H. Phillips, a UK economist who tracked these phenomena in the British economy. In the Phillips curve view, you had to pick your poison - one or the other.

As a corollary, they also believed that growth generated inflation. (The bond market still believes it, largely because it believes the Fed does. That's another article, though.) But the seventies proved the trade-off invalid. In those years, average inflation rose to about 7 per cent, according to Fortune's Encyclopedia of Economics (econlib.org). But average unemployment rose as well, to about 6 per cent. Stagflation was the living refutation of the trade-off argument.

Of course, disinflation, or deflation, as some say we have now, also has its downside. Its bad for debtors, who have to pay back dollars that are worth more than the ones they borrowed.

Still, the lower interest rates that come with lowered inflationary expectations certainly help. These days there's the possibility of refinancing when your debts become too high. And that's something we often realise at a tax time.

In general things are better than they used to be. On the inflation front, we can thank Paul Volcker for that.

Mr Volcker was the Fed chairman who had the courage to wring inflation out of the economy by imposing high interest rates. In a wonderful forthcoming PBS series on economies, The Commanding Heights, he talks about how hard that change was - everyone knew the high rates would bring about recession and pain for small businesses. Especially those businesses that bought high-priced inventory in the expectation that inflation would rise even higher.

But someone had to vanquish the inflation tax. It was tall Paul who did. Next time you see Mr Volcker - he's busy reorganising Andersen these days - remember to thank him.

All this is worth recalling as we sit down to face those painful numbers at tax time. Sure, we have plenty of taxes these days. But at least we are spared one of the ugliest of them all: the hidden tax of inflation.

© Copyright 2002 Financial Times

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