Inflation Tax
The government can take your wealth without raising taxes. An invisible tax not found in law.
A Tax Not in Law
There are two kinds of taxes. One is the official tax explicitly stated in tax law. Income tax, value-added tax, property tax — these are determined by law, tax rates are public, and they are approved by parliament.
The other is the Inflation Tax. When the government issues currency, the purchasing power of existing money declines. The number in your bank account doesn’t change, but what you can buy with that money decreases. This is effectively the government taking part of your money.
But this “tax” is not recorded anywhere in tax law, is not voted on in parliament, and no bill arrives at your door. That’s why most citizens don’t realize they’re paying this tax.
How the Inflation Tax Works
A Simple Example
Let’s say there is a total of 1 million won in circulation in the economy. You have 100,000 won, so you own 10% of all currency.
The government issues a new 1 million won through the central bank. Now the total currency in circulation is 2 million won. Your 100,000 won is still 100,000 won, but your share of all currency has dropped from 10% to 5%. As new currency is absorbed into the economy, prices rise, and your purchasing power is cut in half.
The government spends the newly issued 1 million won — before prices rise. Your lost purchasing power has been transferred to government spending.
Why Governments Choose Inflation Over Taxes
When the government needs additional revenue, there are three methods:
- Raising Taxes — Faces the most political resistance. Voters immediately object.
- Issuing Government Bonds — The burden is shifted to the future, as repayment comes from future taxes.
- Issuing Currency — Faces the least resistance. Purchasing power decline happens gradually, the cause is unclear, and it is not perceived as direct “taxation.”
The logic of Frédéric Bastiat’s “That Which Is Seen and That Which Is Not Seen” shines here. The effects of government spending (new roads, welfare programs) are seen. Meanwhile, everyone’s declining purchasing power as a result is unseen. Politicians boast about what is seen and remain silent about what is unseen.
Who Suffers Most
The inflation tax is regressive. That is, the poorer you are, the greater the proportion of wealth you lose.
Cash Holders
Wealthy people hold most of their assets in real assets or financial assets like stocks, real estate, and bonds. These assets see their nominal prices rise along with money supply growth, offsetting inflation.
In contrast, low-income people hold most of their assets in cash or deposits. Cash is the asset most vulnerable to inflation. The inflation tax is concentrated on those holding cash.
Wage Earners
When prices rise, asset prices respond immediately, but wages adjust later. During this time lag, the real purchasing power of wage earners continues to decline. Salary negotiations happen once a year, but prices rise every day.
Bondholders and Savers
People who lent money (creditors) and those who saved receive money back with reduced real value due to inflation. Meanwhile, those who borrowed money (debtors) effectively repay less value. The government is the largest debtor in history, so inflation is a mechanism for the government to repay its debt with citizens’ savings.
Historical Examples
Weimar Republic (1921-1923)
To pay war reparations from World War I, the German government issued vast amounts of currency. The exchange rate went from 60 marks per dollar in January 1921 to 420 billion marks in November 1923. Citizens’ lifetime savings became worthless paper, and the middle class fell into poverty overnight.
Zimbabwe (2007-2008)
Due to reckless currency issuance by the Mugabe government, the inflation rate reached 79,600,000,000% in November 2008. 100 trillion Zimbabwean dollar bills were issued but couldn’t buy three eggs.
”Moderate” Inflation in Developed Countries
Extreme cases aren’t the only inflation tax. America’s 2% annual inflation target halves purchasing power in 35 years. “Stable” inflation means stably stealing wealth.
Since the Nixon Shock in 1971, the US dollar has lost 86% of its purchasing power. No tax bill has ever declared it would take 86% of citizens’ wealth, yet inflation quietly achieved it over 50 years.
Why Target 2%
Most central banks target 2% annual inflation as a “price stability” goal. But 2% doesn’t mean prices are stable — it means purchasing power falls 2% every year.
From the Austrian school perspective, the very concept of an “optimal inflation rate” is contradictory. In a sound money system, prices naturally decline as productivity improves. When technology makes things cheaper to produce, raising prices through currency issuance robs citizens of the benefits of productivity gains.
Bitcoin: Currency Where Inflation Tax Is Impossible
Bitcoin is a currency where the inflation tax is structurally impossible.
- Total supply of 21 million coins — no government, institution, or individual can issue more
- Halving causes issuance to gradually decrease — inflation rate approaches zero over time
- Rules enforced by code — cannot be changed by political decision
Ludwig von Mises called sound money a “brake on government fiscal irresponsibility.” Bitcoin implements that brake in mathematics.
Connected Concepts
- Nixon Shock — The moment when constraints on the inflation tax completely disappeared
- Fiat Money — The currency system that enables the inflation tax
- Cantillon Effect — Who receives new currency first
- Moral Hazard — The perverse incentives created by unlimited currency issuance
- Sound Money — The conditions for money without inflation tax