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The Big 3: Inflation, Taxes, and Purchasing Power

June 22, 2021
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Inflation, taxes, inflation, taxes, inflation, inflation....and taxes. How many times have you heard these words the last year? Lately, you may be hearing about a proposed increase in taxes and you may be feeling the impacts of inflation –– amongst other things. Regardless of if the topic is inflation, taxes, printing money, stimulus plans, CPI, etc., the question on everyone's mind is still the same: How does this impact me? First, let’s start from the beginning.  

 

How did we get here? What’s going on?  

 

As you probably already know, over the past year the government has passed record amounts of stimulus to keep the economy afloat through the pandemic. Most economists agree that to some level, this was necessary, and I agree with that. To do this, the government needed to “create” the money to pump into the economy through direct payments, loans, increased unemployment etc. However, one of the risks that follows is inflation: the increase in the cost of goods and services. It’s important to note that there’s a large camp of economists that argue this will not be a sustained period of inflation, and as supply levels increase to meet demand, costs will stabilize and eventually decrease. Largely, I do agree with this. However, I think it will take time. For example, the price per thousand board feet of lumber has increased nearly 300% since the start of the pandemic yet there has been no decrease in demand. Signs point to current inflation being temporary (gas prices for example), but not all of it. We haven’t seen a decrease in starting wages, and you may have become more aware of the hiring signs at grocery stores, restaurants, and retailers approaching $20/hour. When you combine increased wages with the rising cost of goods, the only things that can keep costs to consumers level would be if businesses can figure out a way to cut costs (technology? outsourcing?) or increase their sales enough to maintain their desired profit levels. Otherwise, the cost to the consumer will need increase. I’ll come back to this later…  

 

Additionally, the country’s debt has skyrocketed due to the record amounts of stimulus. So how do we go about paying it back? The government generates its revenue primarily through taxation, and when people aren’t making money or spending money, the government’s revenue suffers. When you spend money you don’t have, you acquire debt. To make matters worse, we already added to our debt levels pre-covid. So, we were increasing our debt levels when things were “good”, and we increased our debt levels at an accelerated rate when things were bad…Now what? Do we cut spending to create a surplus based on current revenues? How can the government increase its revenue? 

 

How are we going to pay for this? Who will it impact?  

 

The Biden Administration has proposed for tax increases to both pay for the spending that has already occurred, and for more spending on things like infrastructure and job creation. Although nothing is final, some of the proposed increases are the following: 

  • Increased income taxes for those earning over $400k 
  • Increased corporate taxes from 21% to 28% 
  • Increased capital gains tax (20% to 39.6%) on taxpayers whose income exceeds $1million  

 

Theoretically, these tax increases are supposed to impact “those who can afford it” which is often described as the top 1% in our country. In theory, this makes sense, and is mostly true that the top 1% can afford. However, those who “can’t” afford it, who aren’t supposed to be impacted, will actually be significantly impacted. Increasing or decreasing taxes has intended outcomes and unintended consequences and creates incentives or disincentives. If the intended outcome and incentive for increasing taxes is to reduce debt and create jobs, what are the unintended consequences and disincentives?  

 

If a corporation’s profits are reduced by 7% overnight due to increasing corporate taxes from 21% to 28%, they’ll be put in a position where they can accept the loss in profit for the good of the people (assuming they can afford it), or they will need to figure out how to make up for this loss. With a new precedent being set for starting wages, increased cost of goods (at least for now), and potentially a 7% increase in corporate taxes, what can consumers reasonably expect to happen? How can your bill at the grocery store not increase? One logical conclusion is corporations start to spend less money. As a result, there would either be a decrease in wages or less jobs, both of which would be harmful to the 99% of people that were supposed to be unharmed by the increase in taxes. If corporations don’t go in that direction, which hopefully they don’t, corporations are forced to pass along these increases in costs to the consumer to maintain current levels of profit. As a result, I see one of two unintended consequences:  a decrease in job creation or increased expenses. This effects 99% of the people who “won’t” be harmed. 

 

Regarding the proposed increase in the capital gains tax from 20% to 39.6%, I think it’s important to understand how a majority of capital gains are created. The form familiar to most, is through a taxable investment account. If you invest $1,000 and it grows to $2,000, you have an unrealized capital gain of $1,000 that is subject to capital gains tax. Simple enough. The area of capital gains that is usually forgotten is in the ownership of a business. When a business is sold for a profit, there is a capital gain. For example, a business owner may have invested $500k to start a business, and many years later sold the business for $5 million. The sale of that business is taxed as a capital gain. Although that business owner may not have been making anywhere near $1million/year, under proposed tax plan, the sale of this business would be subject to a 39.6% federal capital gains tax (not to mention, depending on what state the business is in, they would likely pay taxes at the state level as well). As a result, the unintended consequence is the disincentive to invest in both the stock market and in a business. If you’re in the top 1%, why would you continue to invest at your current levels if your profits are going to be cut in half by capital gains tax increases? If there is less investment in business, the likely outcome is less jobs. If there is less investment into the stock market, the likely outcome is increased spending. If there is an increase in spending (demand) the likely outcome is an increase in the cost of goods – in other words, more inflation, which will impact the other 99% of people.  

 

In summary, I have a really hard time understanding how increasing taxes is the correct solution to the problem. I’m struggling to understand how the lower and middle class aren’t going to be hurt most by what is being proposed. It’s important for you to think for yourself, think about both the intended and unintended consequences, and follow the incentives and disincentives that are created by these proposed changes. Draw your own conclusions and think: What will I do as a result? What’s my plan?