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Home Publications Blogs Beat the Press How Is Inflation a Highly Regressive tax on Wages?

How Is Inflation a Highly Regressive tax on Wages?

Friday, 20 April 2012 05:44

No one expects great economic analysis from the Post, especially on its opinion page, but the conclusion of David M. Smirk's piece on the euro crisis must have left millions scratching their heads. The column told readers:

"Inflation, of course, is a highly regressive 'tax' on already stagnating wages and salaries. No wonder European governments are dropping like flies."

Actually, most wages follow in step with inflation, although some workers do see declines in real wages when inflation rises. However, the biggest losers are creditors who are almost by definition wealthy, since people owe them money. If a creditor has lent out $100 million at 2 percent interest (e.g. buying a 10-year U.S. or German government bond) and the inflation rate rises from 2 percent to 4 percent, this creditor has lost an amount equal to 100 percent of his expected income or 2 percent of his wealth. This is a far larger loss than any worker could experience as a result of this increase in the inflation rate.

Also, most workers are debtors to some extent. They are likely to have mortgage debt, credit card debt, student loan debt and or car debt. A higher rate of inflation means that they can repay this debt in money that is worth less than the money they borrowed.

The other strange part of this assertion is that inflation is the reason "European governments are dropping like flies." Of course the euro zone has very low inflation right now, even though many economists advocate a higher rate of inflation. It therefore makes no sense that inflation is causing governments to fall.

The piece also bizarrely includes Mexico on a list of countries that have experienced a boom following a bout of austerity. Mexico's economy has had very weak growth, especially for a developing country, over the last two decades.

Finally, the piece includes the assertion:

"some of the periphery countries in the area of fiscal policy have, to put it bluntly, a history of cooking the books. They deserve the bitter medicine [austerity]."

This is an interesting moral position. The vast majority of workers, students and retirees in countries like Greece and Spain who are suffering from unemployment, higher tuition and pension cuts had no idea that their leaders were cooking the books.

By contrast, highly paid global financial policy strategists like Mr. Smirk might have been expected to recognize the asset bubbles that were driving the U.S. and European economies. They should have warned political leaders and the public at large that these economies were moving into dangerous terrain. If someone "deserves" to suffer we might think the people responsible for reckless policies would be the most obvious candidates, not ordinary workers and retirees.



For the folks who think that inflation leads to lower wages, here is a series showing the average real (inflation adjusted) hourly compensation (wages plus benefits) and the rate of inflation.




These series give the basic story, although they are not perfect for reasons that you do not want to hear about. If you can see a negative relationship (i.e. higher inflation leads to lower real wage growth) you have better eyesight than me.

Comments (14)Add Comment
Euro Piece
written by sherparick, April 20, 2012 8:23
The rest of the article was better then the lead paragraph. He actually wrote something I thought I never see on Fred Hiatt's pages:

"...Austerity without a dramatic increase in exports is a recipe for failure. Austerity alone shifts credit exposure even more onto working middle-class families who are already pressed..."
Workers' wages rise in lock step then, eh?
written by ed ericson, April 20, 2012 10:41
Not saying Smirk isn't smirk-worthy, but your assertion: that a hypothetical two percent inflation loss by a bond holder "is a far larger loss than any worker could experience as a result of this increase in the inflation rate" is unsupported by evidence. In my experience as a relatively debt-free wage earner for the past 25 years or so, pay raises bear no relationship to the stated inflation rate and my own wage has been eroded to the point where I make a bit less, inflation-adjusted, than I earned in my first year out of college.

A look at U.S. median wage rates indicates that my experience is far from unique.

Perhaps I made a big mistake by not loading up on debt. But most consumer debt is variable--i.e. credit card debt--and that is always pitched at a usurious multiple of inflation. So I don't think I'm going to win that game either.
of course inflation is a tax, and of course regressive...this is not a secret
written by pete, April 20, 2012 10:45
Since the early 70s, the inflation rate doubled to an average of 4% per year, from a post war average of 2%. Surprise surprise, wages have not kept up with this, and in so far as they have, not nearly at the rate at which the returns on assets have kept up or even benefited from inflation. Look at SP from 1974 to present compared to wage growth. That's exactly how it is supposed to work. Keynes was interested in getting people back to work, not making them rich. Similarly, Krugman posited that Greek real wages are about 25% too high...so it will take a good deal of inflation to get them down to competitive levels, where the marginal value product is higher than the wage.

Due to money illusion, workers are much happier to take real wage cuts through inflation than through nominal wage cuts. Inflation is THE solution to sticky prices...it is the heart of Keynes, a precursor of behavioral economics which is now so popular. Today we would lump money illusion as a framing issue.
ed ericson nails it
written by pete, April 20, 2012 12:06
Sorry, we must have submitted at the same time. Still no clue as to why progressives like inflation engineered by a central bank designed by bankers for bankers. Even Marx knew inflation was a regressive tax. On a related weird note, Krugman does not think the Fed is bailing out Wall St. with 0% borrowing rates and much higher lending rates, while allowing banks to lie about their asset values. Sigh. The Fed is part of the government, and government is good?
nice graph
written by pete, April 20, 2012 3:45
Looks like real wages are kind of stagnant over time. Certainly that is not in keeping with a doubling or tripling of GDP per capita over this period. Plus, using my interocular test, I see a significant difference in real wage growth between the low inflation Breton Woods and the post Breton Woods dual mandate bubble mania.
some peculiar logic?
written by mel in oregon, April 20, 2012 4:46
"progessives like inflation engineered by a central bank for bankers?" nope, bankers don't like inflation because money loaned comes back in worth less. also i don't think krugman said that. but the point you make about banks & the fed is 100% spot on. and i disagree with pete, keynes did want people back to work & he didn't care if they got rich or not. but inflation was a by product of keynes theory which influenced all democrats until the time of carter. what keynes said was when private enterprise wasn't working, then the government had to provide employment to make up the difference. capitalism wasn't working in the 1930s, more to the point, it isn't working now. funny how china has applied keynesian theory to build the best high speed rail system in the world while we have none. they also have 95% of their population covered by national health coverage at a fraction of the cost we pay. and while we worry about some mistakes china has exported to us (tuna, kid's toys, toothpaste), our own prescription drug vioxx probably caused 1/2 million senior deaths from heart attacks & strokes. funny how no one in the media doesn't bring that up. course while our bridges & roads are falling apart, we still have $2.3 billion a week to waste in afghanistan. one final little known fact, when sect of defense panetta was in afghanistan for a pep rally, all troops had to surrender any weapons before proceeding into the hall for his speech.
Old economic rules don't apply anymore
written by Goldilocksisableachblonde, April 20, 2012 5:41
pete , above , is correct.

Inflation is no longer a reliable tonic for debtors , not in a world of adjustable-rate mortgages and credit cards , which are designed to withstand the corrosive effects of inflation. In a world saturated in labor and overcapacity , it's naive to expect wages to keep up with inflation. Your chart shows they haven't been doing so even before the crisis.

We can still say that deflation hurts debtors , but you can only say inflation helps a subset of debtors who have long-term , fixed-rate loans. If that loan happens to be a mortgage loan , they're trapped in their homes , since if they move they lose that benefit.

As a rule , in the battle between banks and workers , the banks win , no matter what.
For Pete''s Sake!
written by Jeffrey Stewart, April 21, 2012 10:14
Pete, exactly where did Marx analyze inflation as a "regressive tax"? Where in Capital is that passage?

What inflation does is lower the wage below that representing the value of labor power. This means workers are paid less than the wage accurately reflecting the value of their means of subsistence. Some might call this increasing immiseration of the working class. It raises the profit-wage ratio and also the profit rate. Inflation that erodes real wages restores profitability and is one way for capitalism to emerge from a falling profit rate crisis that appears as bursting of any kind of speculative stock (1929) or housing (2007) bubble.

The common thread connecting inflation that erodes real wages, tax and breaks cuts for corporations and direct attacks on wages and benefits of workers (as in Greece) is they all contribute to restoring profitability and are all ways for capitalism to recover from a severe crisis caused by a falling profit rate.
written by Ellis, April 21, 2012 10:45
I don't think many people realized that inflation is our friend. The chart, by the way, is not of wages, as Baker claims, but total compensation. That includes the cost of health benefits, which have skyrocketed, even as people have to pay gazillions more in out of pocket costs -- a rip-off of staggering proportions.
I also wonder how accurate the inflation statistics are, what with all those little tricks in it, like hedonic pricing and substitution, that are used to reduce the official rate.
it's not
written by Peter K., April 21, 2012 11:41
It's not a regressive tax.

What's a regressive tax is the effects of high unemployment. Banksters like slow growth and low inflation. Employers like a docile and pliable work force. It helps with profits. Plus it's nice to have staff who fawn over you and are not uppity.
written by Calgacus, April 21, 2012 6:27
Pete, your criticism of the "dual mandate" as in I see a significant difference in real wage growth between the low inflation Breton Woods and the post Bretton Woods dual mandate bubble mania is astounding & gets history & theory backwards. You seem to be saying here and elsewhere that the Fed should get rid of the full employment mandate & having only an inflation mandate, like the ECB monstrosity.

The Keynesian era had better real wage growth & everything else, because government spending, aided a bit by central banks, combatted unemployment. The change in the 70s-80s was to de-emphasize unemployment, not over-emphasize it. The Fed's mandate has become less dual, not more dual.

Central banks cannot really engineer, or fight inflation, or unemployment. Exception - by ignoring their regulatory function and abetting bankster fraud, they can effectively indulge in disguised fiscal spending. Other exception - in the short term, they can fight inflation by reducing demand by causing unemployment by hiking interest rates. But in the long run, higher rates cause inflation, rather than fight it, by several means. High unemployment, by reducing supply can cause inflation. So basically they can just cause inflation & unemployment & then maybe fix some of the damage they caused. The best policy is an inactive, stable, low interest rate, strict regulation central bank, like the Fed from FDR til around 1960.

If one of the dual mandates should be jettisoned, it should be the anti-inflation mandate, as it is the main excuse for destructive rate hikes, which aren't even really effective against inflation, but are effective in creating unemployment & instability.

Inflation in a high-employment economy is a progressive tax, not a regressive one. But the main thing is to get to high employment. It's very easy for the government to do, and only the government can do it. But the charlatans of un-economics have been very successful in convincing people that it is hard and that the gubmint can't, shouldn't do it.

Try using some statistical tools
written by longtooth, April 21, 2012 7:23
I suggest you use some simple statistical methods to see the relationship between real wages and inflation rather than trying to use your eyesight. In fact, why didn't you show the data in relationship form in the first place?????
What my eyes don't tell me...
written by LSTB, April 22, 2012 9:04
Taking the two datasets together, and resetting the CPI to equal 100 in 1/1/2005 as the real wage dataset does, and then calculating the annual and five-year growth rates...

I get a correlation coefficient of -48.5 for the annual growth rate, and -42.9 for the five-year growth rate.

For just the annual growth rate starting in 1985, it goes up to -35.1.

This doesn't disprove Dean's argument, since these datasets together might omit some other important factor, nor do they tell us whether inflation precedes real wage loss or vice-versa.

Bless FRED for Excel, and all who use it.
That's Smick with a 'C'
written by John H. McCloskey, April 22, 2012 1:53
Though this freelord sounds pretty detestable too, he is not fit to be compared with THE Smirk, which is, of course, the Smirk of Janesville, [url]http://j.mp/cwH4gU .

More substantively, the peanut-gallery peanuts confirm my impression that, what with the Chicagonomics an’ the cocktail nappies, hardly an analyst is now alive who would recognize a _rentier_ at fifteen paces. ¡Talk about "the invisible man"!

Happy days.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.