Summary: Inflation as a Form of
Taxation
This
book is about inflation. Inflation is defined as a continued
depreciation of money, or a continued rise in the general level of
prices. Almost unlimited depreciation may especially occur if pure
credit money is involved and the costs of creating money are
negligible. When commodity money is involved – coins made from precious
metals, for instance – the intrinsic value usually forms a limit to the
rise in the general price level. Inflation, particularly when it is a
matter of depreciation of pure credit money, should be seen as just
another way of levying taxes. If the public wishes to hold a certain
amount of real money (purchasing power), this can only be achieved in
times of inflation by replenishing one's nominal money. Since the real
quantity of money (m) is defined as the nominal quantity of money (M)
divided by the general price level (P), the percentage of money
replenishment will have to be equal to the percentage of inflation.
Although
inflation is explained mainly by monetary factors in the final analysis
it is not a purely economic phenomenon. For that reason the
deeperseated causes of an excessive supply of nominal money are
examined. The operative factors are divided into three categories:
socio-political, institutionally objective, and institutionally
subjective factors. The socio-political factors are mainly connected
with the struggle for redistribution of prosperity; the institutionally
objective factors relate to the more technical organization of finance
and banking; the institutionally subjective factors refer to the
interests which money-creating institutions have in an excessive supply
of money.
The
supply of money is excessive if the supply of nominal money in real
terms is greater than the demand for real money. Excessive money supply
is not absorbed by the demand for real money and it therefore leads to
inflation. The definition of excessive money supply stems from our
reformulation of the quantity theory, which states that the general
level of prices is determined by the nominal quantity of money supplied
and the real quantity of money demanded. The reformulation is obtained
by rewriting the famous quantity equation MV = PT to a form in which
the real quantity of money (m) is determined by T/V, so that P = M/m.
Our vision of this reformulated quantity theory is mainly based on
investigations into the factors which explain M and m (aside from any
delay in which the effect of M on P is revealed).
Except
in a system of direct credit control, the most important determinants
of the nominal quantity of money are – apart from the behaviour of the
Central Bank – the reactions of the banks and the public. These
reactions can, in turn, be explained by monetary variables. The
ultimate factors determining the nominal money supply are, however,
still to be found in the socio-political, institutionally objective and
institutionally subjective factors mentioned earlier.
The
nominal quantity of money may be determined by factors of supply, but
the real quantity of money is determined by factors of demand. Our
starting point is that, once a certain threshold value of inflation is
exceeded, the public will no longer demand nominal units but real
purchasing power, causing the inflation percentage to assume a
significant role as a cost element. The factors of demand consist of
the permanent and transitory values of income, the real interest and
the percentage of inflation. Our study for The Netherlands indicates
that within this framework a stable relation can indeed be found for
the demand for money. No such relation could be established for the
supply of money. This is a sound reason to include M itself, instead of
the explanatory variables, in the explanation of inflation for The
Netherlands.
The
influence of the real demand for money on the general level of prices
is based on factors of growth, which consist, on the one hand, of the
permanent and transitory real income and the transitory inflation
percentage and, on the other hand, of cost factors made up of the
permanent and transitory real interest and permanent inflation.
It
should be stressed that our explanation of inflation is, by definition,
an explanation of a continued rise in the general level of prices. In
the short term in particular, an autonomous rise (i.e. a rise which is
not explained by our inflation model) may occur in the general level of
prices. However, we have come to the conclusion that in most western
countries these factors do not in the long run have any systematic
influence on the general price level. This does not apply to the
nominal money stock. Our findings for The Netherlands correspond to
those described in the literature: the stock of nominal money affects
the price level with a delay of about two years. Moreover – adjustments
apart – the inflationary influence of an increase in nominal money (M)
on the general level of prices (P) is strenghtened by a drop in the
demand for real money). Ceteris paribus this strenghtening effect will
make itself felt if the real quantity of money held by the community is
taxed more heavily by inflation. The influence of M on P is
strengthened as long and in so far as inflation accelerates. This is
how inflation tax comes into our inflation theory. It leads to the
important conclusion that excess of money supply causes a reduction in
the real quantity of money although the nominal money supply has been
expanding. Thus if monetary policy is aimed at easing the need for
money balances in an economy, this goal cannot be reached by increasing
the money supply. (As regards the need for international money, this
conclusion also holds for the world economy.)
We
define inflation tax as the profits from excessive creation of money
comparable with a gratuitous transfer of capital by money holders to
money-creating institutions. The creation of money is divided
conceptually into the creation required to finance, roughly spreaking,
the growth of the economy, and creation which only finances inflation.
Excessive creation of money involves the latter type. On the one hand,
growth of the nominal quantity of money leads to inflation, but on the
other hand inflation tax requires the nominal quantity of money to
continue increasing. It is a matter of a rather specific application of
the debtor-creditor hypothesis: it is not the real debt that drops, but
– in order to prevent this from happening – the nominal debt that rises
by a percentage equal to the rate of inflation. This specific
application arises from the fact that pure credit money, unlike all
other debts, is generally accepted as a means of payment. However, pure
credit money represents an abstract right of disposition over
commodities for the public and is nevertheless created by the
money-creating institutions exclusively on the basis of monopoly rights.
In
order to define inflation tax, the creation of money is devided into
that which is necessary to finance the maintenance of the existing
inflation, and that which is necessary to finance the growth in the
real quantity of money. Similarly, the seignorage, consisting of the
total revenue from money creation, is divided conceptually into
inflation tax and growth gains.
The
capacity to create pure credit money is founded, as said before, on
monopoly rights. As far as banknotes in circulation is concerned, these
rights are mainly derived from the legislatur; in the case of demand
deposits these rights can be viewed as the monopoly rights which the
monetary authorities have transferred in part to banks (and giro
services). In an indirect system of credit control the extent of
transfer is determined by the cash liquidity which banks are obliged to
have (and in a direct system by means of credit ceilings). By raising
the compulsory liquidity the monetary authorities do in fact retract
the monopoly rights. In the extreme case of 100% reserves, the
seignorage is fully due to the authorities. (Compulsory reserves of
this type only affect the banks' capacity to create money – and their
seignorage –, not the banking business itself.)
The
volume of inflation tax is determined by the product of the real
quantity of money (basis for taxation) and the inflation percentage
(rate of taxation). Although in the short term temporary factors may
cause the rate of taxation and the basis for taxation to increase, the
basis will drop in the long term in accordance with the rise in the
inflation percentage – given the values of the other explanatory
variables. The long-term scope of inflation tax is not boundless
therefore. It is at a maximum if the elasticity of real money demand is
equal to –1 with regard to inflation. In the ten-year period from 1965
to 1974 seignorage and inflation tax for The Netherlands were Fl. 1.9
and 1.2 thousand million per annum, respectively (1963 guilders).
Although inflation was moderate in this period (6% on the average),
these amounts do not differ much from their maximum values. The
seignorage (and inflation tax) is not automatically apparent from the
profit figures of the money-creating institutions, with the exception
of the Mint. However, seignorage does enlarge the basis (especially the
item "debtors") over which the banks receive income. It then depends on
the yield and the costs in the banking business whether and how the
larger basis leads to greater profit. Against the revenues from
creating money, there are the specific costs of creating money. These
costs (which relate by definition to the flow of created money and not
to the quantity of money already in excistence) are, however, slight
for the established banks, in particular when pure credit money is
involved, which is founded to a large extent on monopoly rights.
If
the costs of creating money are not slight – as may be the case in the
"unit-banking" systems of the US – there is a divergence between the
private costs and the social costs of creating money; the latter may
well be about zero for pure credit money based on monopoly rights. The
creation of money then gives rise to a welfare loss. If the costs (i.e.
private costs) of creating money are charged to those who own money,
money which is costly to make will be costly to keep, too. Money, as a
socially (almost) free commodity, has then been made unnecessarily
expensive.
Asimilar
argument applies to the welfare costs of inflation tax. Money, which
can be created practically free of cost from the social point of view,
is nevertheless expensive for the public to keep, because of inflation
tax. In this way an unnecessary economization in money occurs. A loss
in consumer surplus arises which is only partly offset by the revenues
from inflation tax for the moneycreating institutions. The primary
welfare costs of inflation tax then consist of this non-compensated
part of the loss in consumer surplus (excess burden). These primary
costs relate, therefore, to (the non-compensated part of) a quantitive
reduction in the services (productive and comsumptive) of money.
Secondary
welfare costs also occur; these relate to a qualitative reduction in
the services of money. Primary welfare costs of inflation tax in the
Netherlands in the ten-year period from 1965 to 1974 averaged Fl. 100
thousand million per annum (1963 guilders). The marginal cost rate (=
the ratio between marginal welfare costs and marginal revenue) was 4%.
Although this does not seem unduly high at first sight, it should
certainly not occasion inflation optimism. It is worth bearing in mind
that in The Netherlands the inflation percentage in the period
mentioned averaged (only) 6%, and that the marginal cost rate takes a
decidedly exponential course as inflation mounts. Moreover, an optimal
tax structure should not tax at all as near a free good as pure credit
money as long as other tax alternatives are possible. The welfare costs
of inflation tax are not the only welfare costs to inflation. Just as
the interest rate on money holdings does not provide people with a
compensation for inflation, insufficient adaptation to inflation may
also occur in other fields (prices, wages, interest rates, tariffs,
etc.): But even when inflation is fully anticipated, the very nature of
the process will make complete adaptation quite unlikely. An important
example of incomplete adaptation to inflation is provided by tax rates
applied not only to the real, but also to the purely nominal income
(interest, wage). This can reduce the incentive to supply capital,
leading to a loss of production capacity. This loss can, however, only
be seen as welfare costs of inflation in so far as the struggle for
income distribution between the private and the public sector works out
differently in situation with inflation than in one without it.
After all, even without inflation this struggle could result in an
increased burden of taxation and in the same loss in production
capacity. If inflation occurs the downward pressure, on the real
interest rate as a result of decreasing invenstment activity, will be
reinforced by the negative influence of the inflation tax on this rate.
The welfare costs of inflation make it necessary to combat inflation,
and our explanation of inflation indicates, how it must be combated in
its economic aspects: by making the nominal quantity of money
controllable, and controlling it. However, not every form of monetary
policy can be applied to this end. A strategy to achieve these aims
will have to be based mainly on an institutional and a structural
policy. The former can be used to make the quantity of nominal money
controllable; the latter to control this quantity. Institutional
monetary policy tends to advocate a monetarily neutral policy, in that
it aims at equilibrium between money supply and demand with nil
inflation. This does not necessarily mean a set rule for monetary
growth, because this growth could be adjusted for changes in the
permanent values of the explanatory variables in the demand for money
(such as real income). It does mean, however, that in monetary policy
the combating of inflation has some priority over the other
macroeconomic objectives. Unlike institutional and structural monetary
policy, cyclical monetary policy is not suited to controlling
inflation. It might, at most, contribute towards stabilizing inflation
(at a particular level). In that case, an important prerequisite is
that there must be sufficient understanding of cyclical monetary
policy, but this does not appear to be very likely.
International
inflation can be dealt with in much the same way as national inflation.
The former (which is computed as a weighted average of national
inflation percentages expressed in dollars) is also explained by
monetary factors. The most important are the amount of international
money (defined as the sum of national money stocks including
Eurodollars, all converted and expressed in dollars) and the activation
of this money as a result of internal and external inflation tax (=
revenues from depreciation of internal and external dollars). To
facilitate analysis, a two continent world is introduced existing of
the United States and Europe. The causes of an excessive supply of
money (i.e. one leading to inflation) can be classified into
socio-political, institutionally objective and institutionally
subjective factors.
The latter two in particular have contributed, within the "rules" of
the Bretton Woods system, to an excessive supply of money in the past
decade. These rules were unstable in two respects: the interests of the
United States and Europe conflicted with the division of duties; and
the division of duties was itself unstable. It amounted to the United
States seeing to a fixed goldprice in dollars and Europe seeing to
fixed rates of exchange vis-à-vis the dollar. The conflict of
interests arose because the United States would not benefit from a
fixed gold price vis-à-vis the dollar, but (on account of
external inflation tax) would profit from excessive creation of
dollars. As a result, Europe would not benefit from fixed rates of
exchange (on account of waning confidence in the dollar). Under a
system of fixed rates of exchange, private individuals will get rid of
their dollars to the national central banks, which thus wittingly
enlarge the national money supplies (without this being accompanied by
a drop in the covering percentage of their national money stock). So in
this type of system, external inflation tax indirectly influences the
international price level. Under a system of flexible rates of
exchange, the influence is direct, because the demand for real dollars
(by the public and by private and central banks alike) drops; this
activates the dollar and strengthens the positive effect of
international money stocks on the international price level. The rules
of the Bretton Woods game themselves were unstable; they possesed no
inherent forces tending to equilibrium. This gave international money
stocks and the international price level an unsettled character. If,
however, the division of duties regarding the rules had been reversed,
they would have become more stable; such a situation would have
coincided better with both America's and Europe's interests.
The
analysis of internal inflation tax can be applied almost identically to
external inflation tax (defined as profits from excessive supply of
external money, i.e. money held by non-residents). Here, the problems
are more topical, for one thing because of the international
distribution of the revenues from external inflation tax. The most
important theoretical difference between the external and the internal
tax is welfare costs. The welfare costs (with the consumer surplus once
again as the gauge for prosperity) of internal inflation tax may be
compensated, in part or in full, for a country creating external money
by the revenues from the external inflation tax. Such a country may
find the external tax to be so profitable that it puts up with the
internal welfare costs. The welfare costs for the world as a whole
become much lower if all countries would participate in the creation of
an external money.
The
disadvantages for the world as a whole are considerable compared with
the revenues which external inflation tax produces for the United
States. In the first place, the influence of international nominal
money supplies on the international price level is strengthened by
activation of the dollar. In the second place, the external inflation
tax hampers the proper functioning of the international monetary
system. US external inflation tax has in fact been an important cause
of the 1971 monetary crisis, after which the system of fixed rates of
exchange (troughout the world) was largely abandoned. Attempts to
attain a new international monetary order are bound to founder in the
long run as long as the revenues from external inflation tax are
accorded to a limited number of countries.
Other books and articles on this site :
The Path to Sustainable
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LESSONS FROM 20 YEARS GROWTH
DIFFERENTIALS IN EUROPE
Martin
De Vlieghere, Paul Vreymans
Abstract:
While the rest of the world is booming,
Europe continues to lag behind. In spite of its high productivity, high
level of
development, knowledge and labour ethics, Europe's growth is weak
and remarkably dissimular among regions. France, Germany and
Italy are stagnating, and so do Denmark,
Sweden and Finland. They all progressed with less than 44%
over the last 20 years. The Irish
economy grew 4 times faster, gaining 169%
wealth over the same 20-year period. In half a generation Ireland
metamorphosed into Europe's second
richest country, creating jobs for all.
The main cause of
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and is undoing the
entire Private Sector's productivity gains, eradicating
all of its outstanding performance and
productiveness. Europe could improve its overall performance by copying
the Irish
success formulas: Scaling down big
Public Spending, downsizing bureaucracy, and shifting the tax burden
from
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devellops a workable
supply-side strategy and effective cures for
a humane and financially sustainable development.
This
easy-reading book is destined to become a manual for economic
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interested in wellfare,
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concerned about Big
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or questionning their
declining standard of living.
PART 1 - The Economics of Taxation
In a first part of this paper, we discuss the newest developments in
macro-economic theory and taxation policies. We have special attention
for theory relative to optimising tax receipts by Laffer (1985) and the
Barro-Armey theories (1990-1995) concerning optimising prosperity
growth and income distribution. We compare the taxation policies in
different social models, and have particular interest whether the
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jobs.
PART 2 - The
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In the second part we search for the causes of European growth
differentials by means of multiple regression. The main conclusion is
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performances: excessive taxation and a demotivating tax structure, on
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investment on the other hand. We conclude that the public sector in
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with too little recourse for it to achieve its potential wealth
creation.
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In part three we make a case study and analyse performances of two
countries with opposite public policies: Ireland’s with low public
spending and a flat tax structure and Belgium with high levels of
public spending and a heavy direct tax burden. We analyse the effects
on growth, budget, public debt, job creation and social expenditure. We
conclude that only stimulation of the supply-side of the economy rescue
Europe's generous social system and provide sustainable recourses for
the challenges of its fast ageing population. This confirms the
overwhelming importance of production and investment as the prime
social objective.
Part 4 - Loosing Overweight: A slimming Cure
for fat Governments.
In part four, we look at possible scenarios on how to reduce the public
spending as the most effective way to restore dynamism and growth. On
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consequences of a budget-freeze in real terms. We analyse whether
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return our workforce to its real task of creating wealth, and
ultimately restore efficiency and competitivity of both private and
public sector.
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