Inflation Tax

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Is inflation a tax? At first glance, it may be tempting to conclude that it is not. It does not appear anywhere on the statute books. Nobody is charged with collecting it. Yet just like a tax, it is a transfer of wealth not based on free exchange.

The aim of this note is to estimate just how much money effectively changes hands in real terms as a result of inflation. As of September 2017, UK inflation is growing at a rate of 2.8 per cent as measured by CPIH, the new headline index used by the ONS. It is therefore a good time to consider how inflation affects governments, producers and consumers. It is of course impossible to be completely in control of a market economy, and the levers of monetary policy are in the hands of central bankers. But this does not mean that it is any less important to be aware of its effects on cash, savings and debt. Consider a worker with a 1 per cent annual pay rise included in their contract. If the rate of inflation is above 1 per cent consistently for that year, then although their nominal wages have increased, in real terms, they actually received a pay cut. When nominal wages outstrip real wages (see graph below) it means that pay is not keeping up with inflation.

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