Inflation Tax - "Tax On The Inflation Tax"

"Tax On The Inflation Tax"

Although not meant by the term "inflation tax", a related effect is the tax on interest and investment "income" when the tax is levied against the nominal interest rate or nominal gains.

For instance, if someone buys a bond with a nominal interest rate of 6% and the rate of inflation is 4%, their "real" interest is 1.92%.

If, however, they are taxed 25% of the 6% interest "income", or 1.5%, this can be thought of as composed of a tax on real income (0.5%) and a tax on inflation (1.0%). The same principle applies to capital "gains" taxes not adjusted for inflation. In any case, this "tax on the inflation tax" is essentially equivalent to a tax on holdings ("wealth tax") equal to the nominal tax rate times the inflation rate (in example above, 25% of 4% inflation equals 1.0%.) This "property tax" can even apply to non-monetary assets as well as money earning interest. Thus, money itself is subject to both the inflation tax and the tax on the inflation tax, while other assets, on which nominal profit or gains taxes are imposed, are subject only to the tax on inflation.

Another negative effect of this tax is that even inflation-indexed bonds carry inflation risk, as the inflation compensation is taxed.