What if Taxes and Interest Rates were included in U.S. Inflation Metrics?

By Victor Sperandeo with the Curmudgeon


Introduction:

Knowledgeable people have understood that INFLATION is a hidden tax.  In a January 2023 report, Kentucky Senator Rand Paul explained: 

“As the Nobel Laureate, Milton Friedman, suggested in a speech amidst the period of rising prices in the 1980s, inflation can be thought of as a hidden tax for rampant government action. Though the U.S. government has not levied taxes to pay for the $4.9 trillion spent on COVID relief, the American public must still pay a hidden tax.”

Most people grasp this concept, but few if any ask why actual tax increases and interest rates are not included in U.S. inflation indexes (e.g. the CPI, PPI, PCE index and GDP deflator)?

The answer is obvious -inflation gauges/metrics are 100% caused and controlled by the U.S. government. Let’s examine this issue in detail.

Inflation Defined:

A correct definition of inflation will not come from the mainstream media, most economists, political leaders, reporters, or academics. What is taught at all levels of education is that inflation is a “condition of rising prices,” with little or no mention that inflation is actually a monetary phenomenon (more on that below).

The Chat GPT definition mimics previous articles written by Keynesian proponents:

“Inflation is an increase in the general price level of the goods and services that households buy. When prices rise, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power of money — a loss of real value in the medium of exchange and unit of account within an economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time.”

The reality is that rising prices are the direct RESULT of an increase in money over and above goods being produced! Milton Friedman explained it well:

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. … A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.”

John Birch Society says inflation is theft:

“Inflation is a cleaver form of thievery that steals the value of EXISTING money by flooding the nation with (ADDITIONAL) pieces of paper that have nothing of worth backing them.”

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Inflation is Theft

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Cost-Push and Demand-Pull Inflation:

Cost-push and demand-pull are said to be different causes of inflation. Cost-push inflation is due to supply-side factors, while demand-pull inflation is caused by demand-side factors. 

Yet from an Austrian School and monetarist perspective, they really do not exist. They are purely Keynesian terms that try to misdirect the reader away from the real reason for inflation…excessive growth of the money supply.

According to the Federal Reserve Bank of St. Louis, the cost-push argument is a fallacy because the ultimate cause of inflation is excessive growth in aggregate demand, which comes from excessive growth in the money supply.

PCE Price Index Explained:

The PCE price index is the Fed’s favorite inflation gauge. It’s released each month in the BLS Personal Income and Outlays report, reflecting changes in the prices of goods and services purchased by consumers in the United States. Quarterly and annual data are included in the GDP release. 

On Friday, the BLS reported that the PCE price index increased 0.3% from January to February 2024.. Excluding food and energy, the core PCE price index also increased 0.3% month to month.

PCE Change From Same Month One Year Ago:

Core PCE Change From Same Month One Year Ago:

Inflation Lessons from History:

1. In 1910, the average annual salary in the U.S. was $574 dollars. Few women worked while the average household had 4.54 people, so that salary was earned by one worker per household. In 1910 there was no income tax so 100% of wages went to workers.

2.  In 1912, before the income tax was signed into law via the 16th amendment, the highest paid workers were sewing machine operators, earning $669 dollars per year. Henry Ford offered his two seat “Model T Torpedo Runabout” for $590.00 in 1912. (At an auction on March 22, 2023, a Model T sold for $30,050).

3. In 1913 a single worker paid a maximum of 1% tax rate with earnings from 0 to $20,000.  There was also a $4,000 tax deduction. That $4,000 exemption would be worth $127,788.21, adjusted for the CPI today!

4. From 1971 to 2023, U.S. federal income taxes increased at 6.2% per year compounded! Yet the CPI was only 3.95%, because no taxes were counted.  If they were, the CPI would’ve been +10.15% per year during that period.

Taxes and Interest Rates:

The CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services. However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.

Why not include ALL taxes and interest rates in the CPI and other inflation indexes/metrics (e.g. the PCE index and GDP deflator)?

That would paint a truer picture of the erosion of people’s wealth due to rising prices.

One reason is that taxes virtually never fall in aggregate, although interest rates do. Furthermore, government spending always goes up which is a direct cause of rising prices.

Cost of Living if Taxes Were Included in the CPI:

Here is an estimate of what the increase in the cost of living would’ve been if ALL taxes were included in the CPI from 1971 to date.  These are estimated compounded increases from the existing tax base of the specific category, not the taxpayer’s income. 

Note that we are estimating the actual taxes paid; NOT the year-to-year difference or change in taxes!

If all taxes were included in the CPI calculation from 1971, the estimate would be 18.67% per year!  And that does not include interest rates on mortgages, car payments, and loans, which are impossible to quantify.

Curmudgeon Comment:

The increase or decrease in home prices is not included in the CPI. Instead, there is a “hocus pocus” calculation of “owners’ equivalent rent” which is not correlated with home prices.  In the SF Bay Area, the median price of a single-family home rose 22.6% from a year earlier, according to the San Jose Mercury.


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Victor’s Conclusions:

Taxes and interest rate increases are not included in the CPI in order to deceive the public as to the real “cost of living.”  They are excluded from Inflation indexes/gauges so the U.S. government in power can’t be blamed for rising prices.  

The U.S. government defines and refines its inflation gauges to be flexible in order to make the political party in power look good.

End Quote:

From Henry Hazlitt’s famous book “Economics in One Lesson:”

“If a government resorts to inflation, that is, creates money in order to cover its budget deficits or expands credit in order to stimulate business, then no power on earth, no gimmick, device, trick or even indexation can prevent its economic consequences.

The consequences of inflation are malinvestment, waste, a wanton redistribution of wealth and income, the growth of speculation and gambling, immorality and corruption, disillusionment, social resentment, discontent, upheaval and riots, bankruptcy, increased government controls, and eventual collapse.”               Henry Hazlitt

 

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Be well, stay healthy, success, good luck and till next time…..

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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