Tax Policies

DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle

No, Tax Cuts Don’t Cause More Inflation

Cutting taxes doesn’t add units of currency to the economy

The narrative to attack any tax cut and defend any increase in government size is reaching feverish levels. However, we must continue to remind citizens that the constant bloating of government spending and the increasing of the size of monetary interventions are some of the causes of the widespread impoverishment of the middle class.

Constantly increasing taxes and diminishing the purchasing power of the currency is wiping out the middle class in most developed nations.

Currency printing isn’t neutral, and it never is. It disproportionately benefits the government and massively hurts real salaries and deposit savings. It’s a massive transfer of wealth from savers to the indebted.

The latest dogma is that tax cuts are negative because they boost inflation. However, it’s yet another fallacy predicated on the idea that money is better off in the pocket of the government.

Inflation is the destruction of the purchasing power of a currency, not “rising prices.” Prices don’t rise in unison because of an exogenous factor such as a war unless the quantity of currency issued is higher than the growth in the productive sector.

Cutting taxes doesn’t add units of currency to the economy. It’s the same quantity of currency, only a bit more of it ends up in the pocket of those who earned it.

When governments reduce taxes, the citizens and businesses that have earned money have more in their pockets. Some might spend it, others might save it, which means investment, and others might take more credit. Tax cuts are only inflationary if they boost an extraordinary and unjustified credit impulse. This is rarely if ever the case.

A unit of currency in the hands of the government is certainly going to be spent, adding even more money into the system via debt and deficits. A unit of currency in the hands of those who earned it isn’t just likely to lead to a better capital allocation, it’s also fair.

Inflation is a tax and a policy. Governments benefit from inflation, collecting higher receipts because of the inflation impact on tax revenues, while citizens suffer elevated prices, higher direct and indirect taxation, and lower real wages.

If increasing the size of the government is always dangerous, it’s even more perilous in times of high inflation because the risk of malinvestment becomes a certainty.

There has been a massive campaign against any tax cuts all over the world, which adds to the view that all government spending is justified. The concepts of efficiency, saving, and prioritization have been abandoned, and the administrative state is perceived as an entity that can’t perform any of those measures and needs constantly rising revenues to undertake its duties, yet all is false.

Taxes aren’t set because the government needs more revenues but to pay for services, and they’re adjusted to the reality of the economy. When the public sector becomes an all-consuming and never-saving entity, it doesn’t contribute to growth and productivity: It prevents it.

Governments use any excuse to increase their size in the economy, and using constant emergencies or alleged crises is the easiest way to advance a confiscatory and extractive view of the economy in which citizens and businesses are viewed as cash machines for the political sector, and the private sector is at the service of the government and not the other way around.

Tax cuts don’t increase inflation— it’s the giving of a bit more of the existing money to the ones who earned it. What increases inflation, always, is bloating government spending and perpetuating deficits and then monetizing them by printing constantly depreciated currencies.

Government spending isn’t the engine of the economy. Tax hikes aren’t the only solution to bad administrations. Printing money isn’t a tool for growth but one for cronyism. Upside-down economics doesn’t work. We need to return to monetary and fiscal sanity. A tax wedge of almost 40 percent of income isn’t normal: It’s confiscatory.

If we want to reduce inflation, we need to limit the uncontrolled policies of those that create it: central banks and governments.

There has been a massive campaign against any tax cuts all over the world that adds to the view that all government spending is justified.