Knowing how taxes affect inflation can help you make informed decisions when it is time to vote on tax hikes or for the politicians who represent you. Especially in these days of economic upheaval, it is smart to study the symbiotic relationship between taxes and inflation. Although you may have a working understanding of inflation and taxes, chances are you may not have noticed the connection between the two and how one can cause the other. Let's go deeper into understanding how the two operate together.
What are taxes?
In order to operate efficiently, a government requires funding. Taxes are the money a government receives from its citizens. Tax can be obtained in various ways. Most people pay taxes through their paycheck or whenever they make a purchase, such as food, clothing or entertainment. Not only does the Federal Government impose taxes, but so do state and local governments. Money given to the government ensures a salary for elected officials, provides safe roadways and guarantees local and national security. The government cannot generate its own wealth. It is solely dependent on its citizens for funding. If there are tax problems or tax revenue declines, the government may not be able to perform services that citizens expect.
What is inflation?
Inflation happens when the price of goods rises, but the value of the dollar does not. For example, during a period of inflation, you are required to spend $3 for an item that may have cost you $1 last year. You may have noticed how the prices of goods have changed dramatically over the last 100 years. Going to a movie 50 years ago cost way under $1, and now it costs $10 and rising. This is due to inflation. Inflation simply attacks the purchasing power of a dollar.
Inflation is closely related to supply and demand and the amount of money in circulation. If there is high demand but low supply and the government prints more money, the value of each unit of money decreases. It will cost more money to buy the same product. One unique thing about money is that it is no longer backed by gold or silver. The value of money depends on what you think the value is. If, for any reason, the general population loses confidence in the value of money, it will cause the value of money to decrease further.
How are taxes and inflation related?
Oftentimes, a government acquires extra responsibilities, such as health care and educational programs. These responsibilities require the government to spend, which in turn poses an extra tax burden on the citizens. Oftentimes, the government chooses to tax the medium to large companies and wealthiest citizens with the highest burden. This burden is then visited upon the middle and lower class citizens in the form of higher cost of goods and services. The middle and lower classes find themselves taxed indirectly because the value of the dollar no longer equals the value of the goods.
Did you know there are several types of inflation? Each type of inflation affects the economy differently. In order to understand the effects of inflation, you need to understand what inflation is and how it works.
If you're looking for a hedge against inflation, you will want to search for investments that either have high enough returns that they outweigh the effects of inflation or are geared to compensate for inflation.