The example that follows merely serves to illustrate the importance of a stable currency. I agree with Milton Friedman, who said (in A Monetary History of the United States 1867 – 1960) that “Inflation is always and everywhere a monetary phenomenon”, and define inflation as an increase in the money supply that exceeds the growth in economic output. Only in very recent history have human societies not been on a bimetallic standard – for which Friedman argues primarily because changes in the supply of two precious metals is almost always more stable than the supply of one alone. (Money Mischief: Episodes in Monetary History)
In a society with a progressive tax structure, inflation will result in a nominal and real increase in the effective tax rate, providing a bias towards inflationary monetary policy.
Ex: Ten people make the following incomes in year one (50, 50, 100, 100, 100, 100, 100, 100, 150, 150). There are two tax rates. Income 100 or under is taxed at 10%, income over 100 is taxed at 15%. This constitutes a progressive tax system. The next year, the money supply is increased by 100 (10%) in proportion to income in year one. Incomes in year two are (55, 55, 110, 110, 110, 110, 110, 110, 165, 165). The nominal taxes collected in both years are 115 and 159.5, respectively. Adjusting for inflation (159.5 / (1.00 + 0.10) ), the real value of taxes collected in year two is 145. Therefore, this progressive tax structure results in an effective tax rate that is 3.0% higher when the money supply is increased by 10%.
Tags: bimetallism, inflation, Milton Friedman, monetary policy
