Inflation is the one tax that never needs a vote in Congress

Let me describe a tax for you. It has no rate schedule, no form, no filing deadline and no withholding line on your pay stub. No committee drafts it, no member of Congress casts a recorded vote for it, and no one ever runs for office promising to impose it. It falls hardest on people who save, people who live on fixed incomes, and people whose paychecks adjust last. And the biggest single beneficiary is the institution that owes more money than anyone on earth.

You already know the name. It is inflation, and I want to make the case, in plain terms, that it deserves to be treated as what it is: a tax, imposed without consent, by a system that has every incentive to look the other way.

The Constitution gets this right in a way we have almost forgotten. Article I, Section 7 says that all bills for raising revenue must originate in the House of Representatives, the chamber closest to the voters, precisely so that taxation would be tied to people who have to face an election. Article I, Section 8 gives Congress the power to coin money and regulate its value. Put those two clauses together and you see the design: the people's representatives were supposed to hold both the power to tax and the power over the dollar, in public, on the record. A tax that is levied by a falling dollar skips the first clause entirely.

What the argument says

Here it is in numbered premises, so that you can check every step.

1. Inflation is a sustained rise in the general level of prices, which is the same thing as a sustained fall in what each dollar will buy.
2. Over time, that happens when the quantity of money grows faster than the quantity of goods and services it chases. Milton Friedman's famous line was that inflation is always and everywhere a monetary phenomenon. A supply shock such as a bad harvest or an oil embargo can push particular prices up and can start the process, but a sustained rise in the overall price level needs money to keep expanding behind it.
3. Someone has to be the first to spend new money, and someone has to be the last to see their pay adjust. The first get it before prices rise. The last pay the higher prices with the old paycheck. The economist Richard Cantillon noticed this pattern in the eighteenth century, and it is still true.
4. The largest debtor in the economy is the federal government. A debtor who owes a fixed number of dollars repays them with dollars that buy less. The creditor, who is you if you own savings bonds or a bank account, absorbs the loss.
5. Therefore inflation works like a tax: it transfers resources, involuntarily, from holders of money and wage earners to issuers of money and holders of debt. It does so without a vote.

That is the claim. Now the facts under it.

The family-level arithmetic

Let me use a hypothetical, labelled as one. Say a couple has $100,000 in a savings account paying 1 percent a year, and prices rise 3 percent a year. After one year the account holds $101,000. But the basket of goods that cost $100,000 a year ago now costs $103,000. In buying power, the couple is $2,000 poorer, and the bank's statement shows a gain.

Now compound it. At 3 percent a year, prices roughly double in 24 years, because 1.03 multiplied by itself 24 times is just over 2. The "rule of 72" says the same thing quickly: divide 72 by the rate, and you get about 24 years. A dollar that bought a full dollar's worth in the first year buys about 49 cents' worth in the 25th. A retiree on a fixed pension, with no cost-of-living adjustment, watches that happen in slow motion. At 7 percent the doubling takes only a little over ten years, because 1.07 to the tenth power is about 1.97. Nothing dramatic, nothing on the news, and half the income is gone.

This is not an argument that every price increase is a tax. A bad frost that doubles the price of oranges is a price change for oranges. The tax is the general rise, the one that does not stop when the frost does.

Bracket creep: when the tax collector is a winner twice

For most of the postwar era, income tax brackets were not adjusted for inflation. That produced a perverse result called bracket creep, and a made-up example shows how it works.

Suppose a hypothetical tax code taxes income at 20 percent up to $40,000 and 30 percent on every dollar above that. A worker earns $38,000. Her tax is 20 percent of $38,000, which is $7,600, so she takes home $30,400. Now suppose prices rise 10 percent and her employer, being decent, gives her a 10 percent raise to $41,800. She has gained nothing in real terms. She can buy the same basket as before.

But watch the tax. The first $40,000 costs her $8,000 at 20 percent. The remaining $1,800 is taxed at 30 percent, which is $540. Her tax is $8,540 and her take-home is $41,800 minus $8,540, or $33,260. Deflate that by the 10 percent price rise: $33,260 divided by 1.1 is about $30,236. She started at $30,400. A raise that exactly matched inflation left her about $164 poorer in real take-home pay, and the Treasury collected a larger share of her income without Congress ever voting to raise a rate.

The fix was indexing, which ties bracket thresholds to inflation. It was written into the Economic Recovery Tax Act of 1981 and took effect with the 1985 tax year. You can read the story in reagan's 1981 tax cut and the quiet end of bracket creep. Before that, inflation was a quiet revenue machine for Washington, and it is no accident that nobody in office had a strong urge to stop it.

The 1970s record

If you want proof that this is not just theory, look at the decade that taught it. In August 1971 President Nixon announced wage and price controls and ended the dollar's convertibility into gold, a double move often called the Nixon shock. Controls were tried, loosened and tried again, and prices kept climbing anyway. In 1974 President Ford launched his "Whip Inflation Now" campaign, complete with buttons, which should tell you how serious the response was. By the end of the decade inflation by the consumer price index ran in the double digits in 1979 and again in 1980.

That decade gave us a word, stagflation, for the combination of stagnant growth and rising prices that the textbooks of the time said could not happen together. The cure came only when Paul Volcker, appointed by President Carter and backed by President Reagan, drove interest rates up high enough to break the cycle, at a terrible short-term price. How Paul Volcker broke inflation and why it hurt so much tells that story, and it is worth reading before anyone tells you that inflation is easy to unwind.

The strongest objection

An honest argument has to face the best case against it, so here is the opposing view at its strongest. It goes like this: a little inflation is good. It makes it easier for wages to adjust, because workers resist nominal pay cuts, but will accept a raise that is smaller than prices, so a modest rise in the price level lets firms cut real labor costs without cutting a single paycheck. It gives the central bank room to lower interest rates in a downturn, since rates cannot go much below zero and a bit of inflation raises the starting point. And deflation has real horrors of its own, with falling prices that freeze spending and make debts heavier. That reasoning is why the Federal Reserve formally adopted a 2 percent goal in January 2012, and why most central banks run a target above zero.

Here is the answer, point by point.

1. The argument concedes the tax. "Inflation lets firms cut real wages without cutting nominal ones" means the worker's buying power is reduced without the worker being told. That is exactly the stealth I am describing. The objection explains why some officials like it. It does not explain why a family should.
2. The benefits of a small number do not prove the safety of a bigger one. Even if a target of 2 percent has defenders, there is no automatic stop at 2. The 1970s show how a "manageable" rate can climb and entrench itself, and unwinding it costs jobs. The cure cost far more than the disease had.
3. Compounding is not small. Two percent sounds trivial. Run the arithmetic: at 2 percent a year, prices rise by about 49 percent over 20 years, because 1.02 to the twentieth power is about 1.49. A thirty-year mortgage borrower may like it. The twenty-year saver does not.
4. Deflation and inflation are not the only two options. Stable prices, the old goal of sound money, are a third. The case for price stability is that families can plan, contracts mean what they say, and the legislature, not the printing press, decides what is taxed.

I will grant the objection its one real point: nobody wants a deflationary spiral, and a central bank has to be able to act in a crisis. That is a reason for a clear rule and a credible, limited institution, not a reason to shrug at erosion.

Why this is a family issue

Think about who gets hurt first. The retiree whose pension is fixed. The young couple saving for a down payment in an account that pays less than prices rise. The wage earner whose raise arrives six months after the rent did. And think about who is cushioned: the borrower with a fixed-rate mortgage, the owner of assets that rise with prices, and the government, whose debt shrinks in real terms every year that prices climb. That asymmetry is why this tax is so politically convenient. The people who lose are scattered and mostly do not know it. The people who win are organized and know exactly what is happening.

John Maynard Keynes, no conservative, wrote in 1919 that by a continuing process of inflation a government can confiscate, secretly and unobserved, an important part of the wealth of its citizens. When Keynes and Friedman agree on something, I say the rest of us should pay attention.

There are practical things to say to the other side, too. If a politician in either party brags about "bringing down prices," ask whether he means the level of prices or the rate at which they rise. They are very different promises. For the rate, see How the CPI is built and why it never matches your grocery receipt on how the number is built, and three households and one grocery bill, budget scenarios when prices jump for the household view. And on the debt side of the ledger, twelve questions about the national debt, answered straight explains why the government's incentives point the wrong way. Compare it with your big tax refund is a loan you made to the government for free: in both cases Washington is borrowing from you at a price you did not negotiate.

What a family can do about it

You cannot vote the tax away this afternoon, but you can see it coming and plan around it. The Treasury itself sells instruments built to hold their value against rising prices: Treasury Inflation-Protected Securities, first issued in 1997, whose principal adjusts with the consumer price index, and Series I savings bonds, which began in 1998 and pay a rate that includes an inflation component. The terms change, so read the current rules at TreasuryDirect before you buy anything, and talk to someone you trust about whether they fit your situation. I am not telling you what to buy. I am pointing out that the government itself admits the problem, because it created products to protect savers from it.

The same logic applies at work. A raise is not a raise until you subtract what prices did. If your employer offers a cost-of-living adjustment, that is worth more than it looks. If your pension has none, a flat check for thirty years is a pay cut on a schedule. These are small habits, but a household that checks its real interest rate once a year is already ahead of most legislators.

What sound money would ask of us

Reform ideas range from a firm rule-based approach to tighter congressional oversight to a return to some commodity anchor, and honest conservatives disagree about which is wise. Here is what nearly all of them share. First, the central bank should have a clear, public, measurable job, and be judged on it. The Federal Reserve in plain English and the levers it really holds covers the institution and its tools. Second, Congress should not outsource the dollar and then complain about the result. Third, the government should not benefit from the loss of its citizens' purchasing power, which means disciplined borrowing.

I do not need you to agree on the remedy. I need you to see the tax first. Once you do, every promise to "fight inflation" with more spending stops sounding like a rescue and starts sounding like a second helping.

The bottom line

• Inflation is a tax in effect: it moves buying power from savers and wage earners to the government and other debtors, and no one has to vote for it.
• Run the numbers on your own savings. If your interest rate is below the rate of price increases, you are losing ground even as the balance grows.
• Make sure your raises, retirement income and savings are tied to prices where you can. Ask what your plan or pension does when prices rise.
• Ask every candidate two questions: what is the rule for the dollar, and how will you keep the government from profiting from a falling dollar?
• Never accept "a little inflation is fine" without asking who is paying for it, and over how many years.