Wednesday, March 18, 2009

Will Inflation Mean Higher Tax Rates for All?

Obama has promised to not raise income tax rates on all but the richest of the population, for which he means those over $250,000.* Nevertheless, what if Allan Meltzer is right, and very high rates of inflation are just around the corner due to our rampant printing of money to fund these massive spending increases?

While wages adjust to inflation just as prices do, the tax brackets we face do not (see addenum below). If inflation increases our income at the same rate as prices, there would still be a fall in the standard of living as our average tax rates rise. They rise because more of our dollars will be taxed at the higher marginal rates, and for some of us it will mean being in a higher bracket all together. Really high rates of inflation might not be just "shoe leather taxes" but very real and very economically damaging taxes at a time that would be very counterproductive to a recovery.

Here is a link to IRS data on filers by bracket in 2006, and here are the bracket values in 2006. That seems to be the latest year available.

Addendum: Kipesquire points out that the IRS does index the brackets to some inflation adjustment factor (Thanks Kip!). I remain concerned because my understanding of Meltzer's point is that the inflation will be sudden and rapid once some aspect of the financial system is restored and that massive amount of money sitting in reserves starts to flow again. Given the time lag for data collection, I wonder if the brackets will adjust appropriately in a timely enough fashion.

* Economists are quick to point out, and correct in doing so, that the burden of these taxes will still fall partly on the lower income groups. For instance, various studies have shown the corporate income tax to be a regressive tax.


KipEsquire said...

"While wages adjust to inflation just as prices do, the tax brackets we face do not."

Actually the brackets do adjust for inflation. Only the AMT doesn't,,id=174876,00.html

On the other hand, the wage cap for Social Security taxes also increases for inflation, so that's a bummer.

Suzie said...

I am a bit confused. Are we printing money? Are we borrowing money? Do we have some hidden money in the basement of the treasury? Does it matter? Today in the Washington Post they talked about how the feds are going to buy 1.2 trillion dollars of federal treasury bonds. Does this mean we are printing money to purchase them?