Inflation is a tax. This statement has become almost a truism within hard-money circles. Yet it would seem that no matter how many times we repeat this phrase to ourselves, we are unable to face its implications squarely. There is some underlying psychological barrier that persists in spite of rational attempts to overcome it. We continue to view our inflation-hedging activities as just another form of profit-making activity. True enough, there are entrepreneurial profits involved in successful hedging, since the successful hedger (used in the nontechnical sense of speculator) has successfully forecast the future and has taken efficient action to deal with it.
But in the final stages of runaway inflation, a fundamental shift in perspective takes place. It involves successive panic movements out of cash or cash-related paper investments. It finally involves total distrust of the monetary unit. To quote the old Marxian formula, a quantitative change produces a qualitative change. At some necessarily undefined point, a majority of participants on the domestic economic markets adopt wholly new patterns of trade. The psychology shifts from making a profit denominated in legal tender to making a profit by getting away from legal tender.
What do we mean when we say that inflation is a tax? First, and most important, the expansion of the money supply allows those creating money to purchase goods and services at prices that reflect yesterday's supply and demand conditions, including yesterday's money supply. Those who possess the new money are able to buy these goods before their competitors get access to the money. Only as entrepreneurial forecasts by the public begin to take into account the likelihood of new money coming into existence will the price level begin to respond more rapidly to the new monetary conditions, or even in advance of the creation of new money.
In short, as long as the so-called money illusion operates, and people fail to foresee its impact on prices, those with the new money can redistribute productive goods and services into their own hands. When government has the monopoly of money creation, or when it has first access to any new money created by government-licensed central banking procedures, then government and those on the dole reap the benefits initially. Hence, monetary inflation is a tax.
Only slightly less important is the invisibility of this form of taxation. Not one person in a thousand understands how this process works. (Before Harry Browne scored his publishing coup, not one person in ten thousand understood it, which is why Harry deserves a lot of thanks.) It is too easy for the perpetrators of the redistribution—government politicians—to blame someone or something else: labor unions, businessmen, the weather, Arabs, anchovies, etc. The public is unable to respond correctly to the problem because it has not diagnosed it properly.
Historically, it has only been the breakdown or near-breakdown of a nation's monetary unit that has brought home the truth of the monetary source of price inflation. A recent Wall St. Journal cartoon is all too typical: a housewife is complaining to her husband about the economy. "The real shortage is our shortage of money." That may be the problem for the individual, but on a national basis the psychology of inflation can be broken only when the mechanism of inflation—fiat money—is broken. But the cry for more money is as loud as the cry against those price increases that finally begin proportionately to outstrip the increases in the money supply, as people foresee each wave of new money and frantically enter all markets, thereby bidding up prices in advance. The wealth redistribution effects become too complex to follow; only those on fixed-money incomes are sure losers.
What is the theoretical limit of price inflation? It is the point in time at which no one will voluntarily give up any further scarce economic resources in exchange for government money. Then private individuals revert to barter or to some unofficial alternative medium of exchange, and the government is compelled either to confiscate goods directly or else to reform the currency. The inflation tax has reached its theoretical limit.
STAGES OF TAX REBELLION
Colin Clark, the Australian economist, has studied the history of government taxation very carefully. He has found that in all known cases in which the tax bite took more than 25 percent of national income, the governments resorted to inflation of the money supply in order to accomplish their fiscal goals. Clark has been criticized by Keynesian inflationists for not providing a theoretical reason for why this should be invariably true. Obviously, no such proof is possible. Academic Keynesians smugly conclude that Clark's 25-percent figure is therefore meaningless. It is not meaningless; it is a statement of historical fact, not theoretical inevitability. As a product of historical research, it demonstrates that statists have always encountered political resistance at or below the 25-percent figure and that they have always taken the same route in "solving" their problem. The smug Keynesians—smug before 1967, anyway—are incapable of showing any theoretical reason for why the same old panacea will not be tried once again. Clark really provides an argument about comparative economic history, not economic theory, and he has all the historical evidence on his side.
There are four stages of tax rebellion, paralleling the four stages of any inflation. They are not absolute categories; they are convenient classification devices that fit fairly well in a number of historical cases and may very well be found to fit what is coming in this country. Whether the fit is significant is yet to be seen.
Stage One: Nonmonetary Strategies. Sophisticated tax-shelter schemes, some completely legal (Keogh retirement plan, cattle feedlot schemes, etc.) and others more questionable, that is, risky (offshore tax havens, complicated corporate ownership, etc.), are nonmonetary strategies. The more risky avenues of escape are open to only a tiny handful of relatively wealthy people, since the information is difficult to obtain and those who use them must stay very mobile (for example, Robert Vesco).
There is also illegal defiance. Some individuals just fail to declare portions of their income, especially cash income. This is the most widely used form of evasion. Others declare their ideological opposition to taxation, or some aspect of taxation, and refuse to pay. They may file "Fifth Amendment" Form 1040's. When the authorities think it is worth their time and effort to clobber the ideologues, they move in. The risks of defiance are very high, and the nonideological nature of most people's tax evasion is such that few converts are gained. As long as people think the State is basically an honest institution, or as long as they think they can benefit personally from an obviously crooked State, tax revolt is of the "let them catch me" variety. It is not that important fiscally.
Most people pay most of what they owe, because most of the money is in the hands of middle-class people who are only marginally involved in tax evasion. The tax rebellion has to convert too many people who neither understand the arguments for outright rebellion nor agree with most of them when they finally understand them. In any case, they are not going to take the necessary risks. The tax revolt, as a conscious ideological movement, does not stand a chance—in stage one.
Stage Two: Monetary Strategies. When the State inflates in order to get beyond that general limit of resistance at 25 percent, more or less, of national income, then the public changes the rules. People who are aware of what is happening to the purchasing power of money begin to hedge. They buy hard goods, sign long-term debt contracts, speculate in foreign currencies, and reduce their ownership of mortgages or bonds denominated in fixed monetary returns. These tax resistance groups are not organized. They are seldom even ideologically inclined, although the original source of their strategies may be very ideological (for example, Harry Browne). They start taking action in their own businesses; they read about others who are attempting similar moves. These are tax evasion strategies; individuals are escaping the invisible tax of monetary inflation. But since inflation is not seen as a tax (precisely the basis of its popularity with governments), people feel far less guilty about their involvement in this form of tax evasion. In fact, they pride themselves on their skills; after all, profit is a sign of one's intelligence and forecasting skills. We are in the early part of stage two.
This kind of tax evasion is extremely relevant fiscally. As people increase their skills in hedging against inflation, it becomes even more relevant. Governments are unable to buy as many economic goods as before, since prices rise in anticipation of the increase in taxation, that is, the increase in the money supply. Even worse, the State is unable to buy as many votes. Projects become insufficiently funded (rising prices) and voters lash out against rising prices—the inevitable effect of the inflation tax.
The most difficult aspect about this form of tax evasion, from the government's point of view, is that it is legal. Furthermore, it does not create sufficient guilt in the minds of the successful evaders, thereby lessening the control of the priests of statist salvation over the public. This tax rebellion is basically unorganized, nonpolitical, middle class, and self-sustaining: successful strategies of evasion are imitated. The tax men become desperate to close the avenues of evasion.
Stage Three: Controls. In response to the cries against rising prices, the government makes rising prices illegal. This creates what Professor Roepke called repressed inflation—the economy of shortages. Economic goods are rationed by nonprice means: power, tickets, long lines, sexual favors, barter, etc. Productivity is drastically lowered. But most important, from the point of view of the government, is that government bureaucrats once again gain first access to "money," whether in the form of ration coupons, priority allocation licenses, food stamps, compulsion, or whatever. Inflation tax evasion is once again made illegal and guilt-producing. Hoarding becomes an immoral act against humanity rather than a rational response to the threat of confiscation by the State.
Those who feel guilty or fear the arm of the law refuse to participate on black markets, at least until they feel sufficiently squeezed financially to make profitable a search for illicit goods and the even more important search for moral self-justification for their search for illicit goods. Eventually, everyone who wishes to survive enters the black markets for at least a portion of his economic supplies, but those who were initially patriotic or fearful pay for their personal qualms by having to start from scratch. They have less information, fewer hoarded supplies, and greater hesitancy than their fellow citizens who simply ignored the laws. Initially, there may be few evaders; eventually, the whole society participates. It becomes dangerous to advocate publicly those economic strategies that are economically obvious but officially illegal. Learn while you can. The night cometh.
Some Americans bought gold bullion long before it was legal for them to own it. Then the government legalized such ownership, making "fools in retrospect" out of many patriotic citizens. They had missed the bonanza. Thus is it always with the law-abiding person who trusts his government. The government misuses his trust. Then he learns. And with that education comes suspicion, hatred, and a hostility to law. The government debases its citizens whenever it debases its currency. (It works both ways, of course: "a little" inflation is popular with many debtors because there is larceny in their hearts.)
The Soviet Union found from the beginning that full socialism, which involves restraints on private production and profit, creates shortages and crises so horrible that there has to be some sort of backtracking from the official ideology. Hence Lenin's New Economic Policy (NEP) in the early 1920's, whereby small businesses were allowed some economic freedom. Hence the garden plots in today's USSR—food is more important than ideology. Hence the laxity in enforcing laws against unofficial barter. Whenever Stalinist ideologues temporarily get tough with black marketeers, the central economic plan smashes on the rocks of shortages and delays. These political fluctuations between controls and modified economic freedom make true cynics out of the population. Cynicism is perhaps the one item that economic controls can produce in abundance. After painful obedience to irrational rules comes guilty participation in the survival markets. After guilt erodes, only cynicism remains. Cynicism and fear. And a secret lust for vengeance.
Stage Four: Destruction of Money. Price controls—laws against the most important form of tax evasion—disrupt markets. Unofficial markets replace the hampered official markets. Barter replaces monetary calculation. The division of labor drops as organized markets shrink. Productivity collapses. As money breaks down as a means of exchange, nonmonetary income becomes all-important.
This is the remarkable genius of market responses to artificial impediments: people find ways of escape. When the inflation tax is imposed, they flee to hard goods. When it becomes illegal to flee to hard goods on the legal markets, they flee to hard goods on the illegal markets. When money exchanges finally break down, people begin to escape from the money economy, or at least the official money economy.
At the end of an inflation, the tax finally fails to do its confiscatory work. All taxes are denominated in money. Money is being destroyed. By delaying payment of taxes, legally or illegally, citizens find it easy to pay their obligations. To pay their taxes they sell hard goods or services for paper money—the exchanges now drawing twice as much in currency as it would have drawn a quarter or a month or a week earlier. The governments at all levels in Germany were paralyzed by this problem from 1922 to 1923: they could not collect the taxes fast enough, and by the time they spent the money that had been taken in, it had declined again in purchasing power. The government fouls its own nest so efficiently that every time it tries to get out of the nest it slips, falling ever deeper into its own waste. In the long run, those who are hurt most by the invisible tax of inflation are those who are employed by the government in all but the highest levels of the bureaucracy, those who are dependent upon the government for welfare payments, and those who believe in what government officials tell them, for example, that U.S. savings bonds are a fine investment for one's retirement.
STRATEGY FOR SURVIVAL
Stage One: Official Compliance. Understand that long-run survival in the inflation tax deluge requires flexibility. It is nice to have a clean record, governmentally speaking. It is nice not to have government officials with a personal vendetta against you. Pay up. Only nomads can escape, and the country is not going to be rebuilt by nomads. Yes, the level of taxation is immoral. The means used to enforce the tax laws no doubt involve legalized extortion. The uses to which your tax dollars are put are clearly preposterous. But pay up. Understand that the worst is yet to come and that survival depends largely on a clean record. You are buying invisibility—a very valuable future good.
Stage Two: Speculation. When you see the second stage of mass inflation coming (as I think we can), take evasive action. Buy up distressed property. Buy at auctions. Buy future alternative monies: gold and silver coins, common caliber ammunition, high quality liquor, etc. If you use debt, make it short-term. Make sure it is within your power to pay it off by liquidating a present asset. Use compensated leverage; do not extend yourself beyond your means to pay should a temporary credit crunch come before the final inflationary blow-off. Speculate in goods, not with your survival. If you must have something, own it outright. The main thing is to prepare yourself psychologically for the tax system of the future: mass inflation. If you think you will have qualms about buying and selling on black markets, buy what you think you will need right now, before such purchases are either impossible or illegal.
Stage Three: New Life Style. Repressed inflation paralyzes the modern money economy. Shortages will be everywhere. You will need a nonurban location, independence from public utilities, new (barterable) skills, and above all, invisibility. Keep your principles visible and your profits concealed. Live in that mediocre home with your mediocre clothes and your aging car. Fly coach. Lend a helping hand. If you've got it, don't flaunt it. Cynical citizens who have lost everything to the inflation tax will be seeking vengeance. Stay out of their way. Remember: most people will not escape the coming debacle. The worst tragedy in our nation's history, economically speaking, is fast approaching.
Stage Four: Crafts and Knowledge. Contribute directly to your community's production. Support your local sheriff. Become your local sheriff. Know who supplies what goods at what nonmonetary price. Pay your taxes—denominated in paper money—with all the enthusiasm you can muster; they have dumped the garbage on you, and now you can shovel it back to them with abandon. Get out of any remaining debt. And if anyone asks you how all these things come about, tell him. It all started in 1913: the Sixteenth Amendment and the Federal Reserve System.
Gary North received his Ph.D. in history from the University of California at Riverside. He edits the biweekly Remnant Review economics newsletter and is the commentator on the Gold and Inflation Report, a telephone advisory service. This article is taken from a speech delivered at the National Taxpayers Union Conference in April 1975 and reproduced in Remnant Review, April 16, 1975.