Tax and Legal News - December 2022

Editorial – Inflation instead of taxes?

In March 2021, our editorial reflected on possible future post-pandemic tax reforms. Peripherally, more as an academic excursion into the history of tax theory and policy in (post)crisis periods, we mentioned the war profits tax and the war surcharge of 1916.

So this time, I’d rather focus on a tax that’s been around for a long time, though it technically doesn’t meet the constitutional requirement of Article 11(5) of the Charter of Fundamental Rights and Freedoms, which states that taxes and fees can only be imposed by law. (I will leave for later a detailed analysis as to whether the newly approved windfall profits tax passes the constitutionality test.)

Let’s look at the so-called inflation tax, a concept introduced and first comprehensively presented in 1924 in the work of the eminent 20th century economist John Maynard Keynes, A Tract on Monetary Reform, in the chapter “Inflation as a Method of Taxation”. The income of the state from the issue of money was defined by Keynes as a tax: “The government can in this way [by printing money] secure the disposition of real resources, resources just as real as those it obtains by taxation. ... A government can live by this means when it can live by no other. It is the form of taxation that is most difficult to escape, as the public knows, and which the weakest government can impose when it can impose nothing else.”

Rising government spending and the associated monetization of government debt (e.g. by issuing government bonds) leads to inflation due to the increasing amount of money in the economy, i.e. a decline in the real value of money balances. This depreciation is simply an inflation tax (although economic studies and models are much more complicated and vary in their exact definitions). At first sight, an inflation tax resembles a general consumption tax or a flat-rate income tax and should thus fall on taxpayers roughly in direct proportion to their wealth. Adam Smith would rejoice at the principle of justice fulfilled. The problem, however, is the rigidity of some prices, slower wage increases and retirement pensions, which leads to a rather regressive impact of this tax. It also typically favours the borrower over the lender because inflation expectations are not perfectly reflected.

The current high rate of inflation is clearly having a positive effect on the level of tax revenue collected, with most tax bases rising due to inflation. Of course, the expenditure side of the budget is also growing, albeit typically at a slower pace. However, if the resulting deficit can be kept relatively stable (economists estimate CZK 250-300 billion per year for the Czech Republic), then high inflation itself will have a significant positive impact on the stabilisation of public finances in this and the coming years. The key indicator of the budget deficit-to-GDP ratio (one of the Maastricht criteria, targeted below 3%) will automatically improve due to an inflationary increase in the GDP value in the denominator. And that’s without the need for unpopular spending cuts or tax increases in the numerator. We will pay for it with that less visible inflation tax. No tax return, no payment assessment, no constitutional complaints (and no tax advisor).

The constitutionality of the inflation tax was also considered by Supreme Administrative Court President JUDr. Šimka at the September seminar of the Supreme Administrative Court and the Chamber of Tax Advisors during the discussion of the taxation of the increase in the value of assets caused by the exchange rate difference for an individual (approved by a relatively controversial and debated judgment of the Supreme Administrative Court).

Finally, let me mention the emerging thoughts about the possibility of replacing tax collection entirely by inflation. This is a revolutionary idea. Of course, high inflation is not good for the economy. But neither is a high level of taxation. People are annoyed by both high inflation and high taxes. There’s a limit to the maximum amount of money the state can raise through inflation. The same is true of tax collection. So far, however, conventional taxation is winning. It is more predictable. Tested and studied for years. In our economies, we know how to operate in a tax environment rather than a high inflation environment. Tradition is tradition.