What is an inflation tax and who benefits from it?

Living in a post-pandemic reality in which there is a full-scale war in the east of Europe, we have become accustomed to the constant rise in prices for goods and services. Thus, as a society, the vast majority understands what inflation is. However, when the “inflation tax” appears in public discussion, questions and doubts arise about the meaning of this phrase. So what is an inflation tax, is it a legal tax, and who pays it?

What is an inflation tax?

According to the forecasts of the European Commission, inflation in Poland in 2023 will be 11.7 percent. and will be the second largest in the entire European Union. However, last year’s inflation in our country amounted to 14.4% compared to the previous year. Thus, all the time these figures are significantly higher than the inflation target set by the National Bank of Poland. Such conditions are the natural setting for what economists often refer to as the “inflation tax.”

The inflation tax, although not a formal term and a tax in the full sense of the word, is by no means an incorrect and made-up statement in this context. On the contrary, he perfectly describes the phenomenon that occurs as a result of high inflation. Inflation, as a condition in which there is a general increase in the price level, leads to the fact that for a given amount of money we can buy less and less goods and services. This in turn produces very specific and measurable effects that are not necessarily negative for everyone.

The situation in which money loses value is actually positive for indebted entities. One such entity is the state itself. Debt, including government debt, as a value expressed in a certain amount of money, is depreciated all the time due to inflation. After all, if ten zlotys is worth less and less month after month, ten thousand zlotys or a trillion zlotys depreciate in the same way. Thus, all entities in debt are in some sense the beneficiaries of inflation because their real debt is worth less and less.

High inflation means higher tax revenues

With the real cost of debt declining and the price level constantly rising, the fiscal burden most often remains at the same level. This, in turn, means that more and more money is coming into the state budget from month to month. Higher prices for goods and services mean higher VAT revenues, and higher inflation-related wage levels also mean higher nominal income tax revenues.

In addition, the increase in the amount of money in the domestic economy due to printing by the central bank, despite the fact that in the long run this causes an increase in the general price level, when the government spends newly created money (for example, on benefits or subsidies), this money still have a high value. The decrease in the value of money, also caused by its reprinting, occurs only with the passage of time.

All these factors make the state an indirect beneficiary of inflation. Inflation itself, on the other hand, acts as a kind of hidden tax, called by economists the inflation tax. In an inflation tax, the rate of inflation becomes the tax rate, and the real value of the cash becomes the tax base.

Who pays the inflation tax?

Unfortunately, inflation is an undesirable situation for the vast majority of market participants. Only the already mentioned hidden costs interfere with day-to-day functioning.

At the same time, inflation is burdensome not only for the lowest paid workers, who feel it most due to the often significantly higher growth in basic food, beverages and energy, but also, for example, for entrepreneurs. Most of them, experiencing strong pressure on wages and facing further increases in prices for raw materials and semi-finished products, are forced to translate rising costs into the prices of the goods and services they sell, which, especially in highly competitive markets, is unacceptable. always possible.

The inflationary tax is also extremely strong on people who receive benefits that are not subject to indexation, as well as on people who save for a specific purpose by keeping money in bank accounts.

Can inflation tax be avoided?

Avoiding the inflation tax is not easy. However, there are some ways that can at least partially help to avoid this.

The first way is to diversify your funds. The money lying in our bank account in one currency, with high inflation, depreciate very quickly. Therefore, it is worth thinking about currency diversification, as well as buying various financial instruments, such as ETFs, investment certificates, subscription warrants, stocks or bonds. Of particular note are inflation-indexed Treasuries that guarantee interest rates above inflation.

The second way to fight the inflation tax is to become its beneficiary, i.e. debtor. However, taking out a loan or a loan only makes sense when it is not too costly and when we expect high inflation to be a long-term phenomenon.

Another way to fight the inflation tax, this time just for entrepreneurs, is to account for inflation in the prices of goods and services sold, as well as in planned investments and new collaborations. While such macroeconomic action will continue to drive inflation, it will allow the companies we manage to survive.

Staying with entrepreneurs, we should also mention here the possibilities of using the mechanisms left in the Polish legal system that allow managing monetary liquidity (for example, analyzing assets classified as fixed assets or postponing the moment of tax payment). However, when the specter of insolvency and the impossibility of repaying already taken obligations, due to the ever-increasing costs of our company, looks into our eyes, the possibility of opening restructuring procedures still remains.