Jack M. Mintz: The inflation tax is back. Americans have been hit first but soon we’ll be feeling it too

Financial Post

If current trends continue for the rest of the year, 2021 inflation could hit 6.6 per cent. For an American earning the average per capita income of US$60,000, that is equivalent to a tax hike of US$3,715 this year alone. PHOTO BY FRANCESCA VOLPI/BLOOMBERG

The tab is coming due for the eye-popping public spending of the past year

One of those payments is the inflation tax, which is already a reality in the United States. With Wednesday’s news that Canada’s year-over-year inflation rate is 3.4 per cent, we aren’t far behind. In April, the U. consumer price index rose by 0.8 per cent on a seasonally adjusted basis. That’s almost 10 per cent annualized.

April may well be an aberration so let’s look at the last four months. rolling out its vaccination program and lifting many health restrictions, its CPI rose 0.3 per cent in January, 0.4 per cent in February and 0.6 per cent in March. Add in April and the overall CPI increase is 2.2 per cent in just four months. That’s an annualized six and half per cent.

On the other hand, at the end of April the U. year-over-year inflation rate was just 4.2 per cent — more than in Canada but less than 6.5 per cent. Even taking into account this catch-up effect, the trend is up in 2021 and at far more than the two per cent annual rate that monetary authorities would like to see. The Federal Reserve Board is willing to tolerate a surge in prices so long as inflation eventually moderates — though how long moderation takes is an open question. The 10-year Treasury inflation-protected bond rate suggests that investors expect inflation to be 2.52 per cent annually.

But even if inflation is only temporary, Americans will already have been hit hard by the inflation tax. If current trends continue for the rest of the year, 2021 inflation could hit 6.6 per cent. Like a wealth tax, the inflation tax is also hurting savers by reducing the purchasing power of money. government bond rate was trading at 1.62 per cent.

Anyone paying income tax at a marginal rate of 30 per cent would net only 1.13 per cent annually on an after-tax basis. Subtract the annualized 2021 inflation rate, and investors make a real return of minus 5.5 per cent. Americans can recoup their losses from the inflation tax so long as they are awarded with more income. Despite the COVID recession, average nominal per capita household income rose by $3,255 in 2020, a bit less than the inflation tax.

If labour seeks higher wages to make up for inflation, businesses will have little choice but to raise prices. With accommodative monetary policy focusing on full employment, inflation could take many years to disappear, with the result that inflation expectations lock in at much higher levels. Either that or the Fed becomes worried enough about inflation to raise interest rates and take the wind out of the economy’s sails. Our April inflation rate was 0.6 per cent, roughly equivalent to seven per cent on an annualized basis.

, inflation in the past four months has been more subdued at just 1.3 per cent — though that is almost four per cent on an annual basis. At four per cent, our inflation tax is $2,307 for a household earning $60,000. Once health restrictions are lifted, expect Canada’s prices to jump. The Bank of Canada has already indicated it might have to wind down quantitative easing sooner than initially projected.

The inflation tax is back.

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Source: Jack M. Mintz | Financial Post 

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