Theoretical question for you guys... Does government taxation increase, decrease, or not affect inflation? On one hand, sales taxes drive up prices, which would increase inflation. On the other hand, income taxes decrease income - slowing inflation.
If you increase taxes, you take money out of people's pockets, so they can't spend it, then it does not turn over in the economy, which is a drag on the economy. When recessions hit, the govt. likes to do a tax decrease to give people money to spend and stimulate the economy. The tax cuts have historically worked well, so I think the theory that tax increases slow the economy is well founded. When the economy is slowing, inflationary pressure generally subsides. The assumption here is that all other factors of the economy are generally healthy. The govt. is living within it's means most of the time, budget deficits are not too big. Another assumption is that the tax cuts are evenly applied across the population base. Targeting the poor may be a better deal for the economy, as they can't ever save any money, so you are sure it will all get spent and turn over in the economy. If too much of the tax cut is targeted at the rich, they might just save it, as they already have plenty of money, then it would not turn over in the economy. The saved money could support capital formation to start a business, which is also a good thing, but probably takes a while to be seen in the economy.
Inflation is defined as the overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index and the Producer Price Index. Tax does not play into the inflation calculation that I can see. I'm not sure if taxes are part of the CPI and PPI index formulas. You should find out. It is possible that taxes have no direct effect on the inflation calculations.
I'm quite sure that CPI & PPI are measured pre-tax, but that is just a measurement tool. The economy itself would react to the total price, which would include tax. Thus, higher taxes = higher prices of goods, so more inflation.
Exactly along the lines that I was thinking. So what we have here is too seperate issues, income tax & sales tax - as both affect the economy in seperate ways. Higher income taxes decrease inflation, while higher sales taxes increase it.
So I thought I had figured it out, but something about this just doesn't seem right... Income taxes & sales taxes essentially do the same thing - reduce spendable income. Why would their effect on inflation be different?
So this finally clicked a little while back... The economy would feel the effect of an increase in sales taxes as an immediate increase in inflation, and a less direct & slower increase in inflation for income taxes as businesses pass on the costs. However, over the long-term, both decrease inflation as they both slow down the economy.
key issue is that it's a change in tax that can affect inflation. So I guess technically taxes decrease inflation because there is less money to be spent but because the existence of taxes is constant (remember three certainties: life death and taxes) it is really the change in taxes that affect the economy which is what moves inflation/deflation. By the way, this could be 100% wrong.
