Last week, as she discussed what it feels like to see your standard of living decimated by high inflation, Toña Marturet got at something Venezuelans are getting only too familiar with: that maddening sense that there’s just no proportion between super-fast price rises and stagnant salaries.

We all know that. What we don’t all realize is that making prices rise faster than incomes is not a mistake, it’s a policy.

This goes back to one of the most maddeningly elusive bits of jargon in the economist’s lexicon: the idea of the “inflation tax”. The very idea that inflation is a tax is weirdly counterintuitive for people. I’m here to try to explain it with as little pain as possible.

The Inflation Tax in Eight Easy Slides

Say you have a very simple economy: the only money is $1 monopoly bills, and the only good is apples.

1. There’s a total of just eight dollars in circulation.

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2…and all the economy produces (and consumes) is four apples.
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3. It’s straightforward to see that the price of an apple is going to be two bucks.

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4. Now, let’s say in this economy the public sector takes up half of GDP (a.k.a., $4,) so the government can buy two apples.

The households and firms, meanwhile, control the other $4 (which of course = 2 apples.)

inflation-tax-004

Now say in the government is in financial trouble. Maybe it owes international creditors an apple and the payment is just about to come due. Where’s it going to get a third apple?

Of course, it could just send some soldiers to go and confiscate one of the private sector’s apples, but that can get pretty messy and bloody. Luckily, there’s more than one way to skin that cat, because they can also just…

5. Pick up a phone, call up the central banker, and order him to print up another eight bucks.
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6. Now, there’s twice as much money in circulation. But that doesn’t magically somehow create more apples. Those 16 bucks are still chasing the same four apples we started with.

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7. What do you guess is going to happen to the price of apples if you do that?

You guessed it:
inflation-tax-007

An apple now costs double.

Now, here’s the tricky bit: Merentes isn’t gonna be all buena nota about it and split the new money with the private sector. Not the guy’s style at all. He’s just gonna call the new cash a “loan to PDVSA” (or some other such accounting sleight-of-hand) and hand it all to the government.

8. But guess what that means…

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Yup, the mutherfucker just stole one of your apples. And he didn’t even need any soldiers or anything.

That’s the inflation tax right there. This is what’s going on when you go to the store and see prices going up in an elevator while your salary boes up via the stairs.

Is this a grossly oversimplified explanation that leaves out a million and one wrinkles? You betcha! Does it get at the basic mechanism involved? Yes it does.

The point is, inflation isn’t a policy mistake, it’s a policy. In fact, it’s a tax: a way for a broke-ass public sector to shift purchasing power out of your pocket and into its pocket.

Venezuelans who can no longer afford skyrocketing food prices aren’t going hungry by mistake, they’re going hungry by design.

31 COMMENTS

  1. Which means that those that do not have hard assets such as access foreign currencies (cuentas en $$) and properties are going to get wiped out. This means the government is buying the ‘apples’ by stealing from the most vulnerable people.

    And then Maduro wonders how is it that Villa Rosa almost lynches him after receiving so many benefits in the past.

  2. That is the reason why politicians don’t want to dollarize. They don’t want to give up the printing press, perdon soberania de la patria.

  3. Consider this: even as salaries go up, tax units and tax brackets do not get adjusted significantly or at all. Thus, and salary adjustment “gains” get whithered away by actual taxes.

    Because of inflation’s “chingo”, you get caught by SENIAT’s “sin nariz”.

    • Well, actual taxes in Venezuela are basically a non-factor. Very few people actually pay them. Entirely from a moral point of view, if I still lived there I would avoid paying them as much as possible.

  4. I’m still not understanding how the parallel rate is staying steady. Has to be someone selling dollars right?? Inflation in the country is still rising but the dollar today rate stays steady all this time… Any ideas what’s going on??

    • Bueno, because this example is really really simplified. What drives inflation is much more complex than this, including not just money creation but the expectation of money creation. For a few months this year Perez Abad managed to actually slow the rate of new money creation to below the rate of inflation, meaning real liquidity started to go down. At the same time SIMADI’s been allowed to creep most of the way up to the DT level. So there’s less desperate pressure for parallel dollars.

      But now Perez Abad is out, and PDVSA’s pagaré at BCV is rising again so…

      • Francisco, What’s your take on Perez Abad? Was he a sensible voice inside the government that got axed because of it or was he just another yes man that was removed for unrelated reasons?

      • I remember reading somewhere that DT and the venezuelan central bank had an agreement on something? and the bank dropped their lawsuit against the website in the states? does anyone know what that was all about? and is there other sources for the parallel rate in cucuta?

    • Thats because now they are waaaaaay lest people buying dollars. after buting food, It’s hard to have “extra” cash at the end of the month to boy $$ for savings, or to replace the phone I lost, or to buy that one book I need for college.

      • thanks for the response you guys, so yes, i realize that simaldi is going up, but does that mean there have been more dollars that were able to go through simaldi, last time when it was real cheap, there was like no dollares being sold through simaldi. ok so i get that it gives less pressure to DT rate, and now less people are buying dollars as they are using it to buy food these days.

        but still venezuelans need to buy dollars to buy anything outside of the country right? i mean to sell if you own a business…. unless somehow simaldi is making it a little easier for people to buy from now that the rate is higher? but anyways, its just that all my relatives out there are telling me how much inflation is going up, but yet I just didnt see the parallel rate moving at all.. which was odd to me, but i guess if things inside the country is going up, and no one is buying dollars, that kind of brings us to our situation now.

  5. Almost every business is a CONTRIBUYENTE ESPECIAL for Seniat with all the crap that goes with the “honor”.
    As for dollars, a lot of people are selling dollars to survive, plus a lot of people are sending dollars to family members. And not many people have bolivars to buy dollars.

  6. OT. I hear rumors that some of the talks between the government and the MUD are to discuss what will happen after Maduro is gone, and this supposedly includes not going after those that have robbed the country or committed other crimes against Venezuela and its people. The criminals would then be free to leave the country and enjoy their loot. This is totally unacceptable. The only message that this would convey is that you can steal as much as you want without any consequences. Some people tell me that we shouldn’t go on a witch hunt, but that’s not what that is. It just people paying for their crimes, including irresponsible money printing for their own gains (political or financial)

    • Augusto Pinochet was personally responsible for 3,000 murders and served as a Senator for 2 decades after handing over power…

      FARC butchered nobody-knows-how-many-people and their top guys get seats in congress.

      Transitional justice is disgusting.

      Unacceptable, though? No. It’s keeping these nutters in power that’s unacceptable.

    • Also… irresponsible money printing is not a crime. It is an horrendously bad policy, but it is not a crime. The price to be paid for being so bad at running the country is just political – people realizing they shouldnt vote for them anymore.

      If that was the only category of problems with chavismo, things would be better. Unfortunately they have commited actual crimes, and destroyed institutions by imposing their “we do whatever the hell we want” mentality. But lets keep things separated,”this is a very bad decision taken by very bad reasons” and “this is illegal” are not the same categories

      • I suppose that it depends on which criminal code you are following. But, even in common law, negligence can rise the level of “criminal”.

    • As Chilean I lived during the “transición” process after March 1990. The are many things anybody can say where disgusting, in special the awful amount of time to start trials for abuses during the dictatorship, because until Pinochet was arrested in London he had enough power to stop investigations.

      We had the “Boinazo”, the “Ejercicio de Enlace”, a Congress with a lot of awful people in both chambers and a Supreme Court even worse about Human Rights.

      And also many people in the Government that feared about every single move they did because the fragility of the country. I remember when Pinochet was arrested in 1998 that my parents were a little scared that the stability of the country could break apart because of that. And they weren’t the only ones of that. Every single wound created in the dictatorship was open in that time

      But there were people like President Frei Ruiz-Tagle (DC whose father, Presidente Frei Montalva, was killed during the dictatorship) and José Miguel Insulza (socialist and Minister of Foreign Relations) that confront a government divided in how to manage the crisis. At the end they understand that defending Pinochet (as being Senator and with a Diplomatic Passport) and the government was more important that any of their emotions towards the dictator.

      And then when Ricardo Lagos was president, still to defend Pinochet until he came back to the country.

      Weren’t the things they want to do, but the things the country need stay stable and move forward while trying to repair all the damage of the past. At the end, while he was detained in London, all the power Pinochet had collapsed like a house of cards and that allowed to do a lot of improvements and to start trials, while in other aspects time did a lot.

      If Venezuela someday goes to the same kind of transition process, any president would need to “tragarse un sapo” in industrial quantities. There will be a lot of things to do not because he would like it, but because a greater good.

      Transitional justice isn’t the greatest kind of justice, but if can help to avoid or stop a crisis and to start to rebuild Venezuela, it will be enough,

      As Patricio Aylwin said, “que se haga justicia, en la medida de lo posible”.

  7. En Venezuela nunca ha habido socialismo por que para que haya socialismo es necesario que exista un Estado , que mande , que opere , que funcione como institucion …..y Venezuela lo que ha tenido es un remedo de Estado , o a lo sumo un munon de Estado , inoperante, desarticulado , el engranaje servil de unos ilusos o unos granujas . La gran tarea en Venezuela es construir un Estado , que lo sea en plenitud y no como simulacro , El estado en Venezuela es un espejismo, una ficcion a la que atribuimos una voluntad de la que carece por que quienes actuan realmente usando los recursos de los que se le dotan (para su propio beneficio y/o para servicio de sus delirios y ambiciones) , son las viles mesnadas de personajes que seducen el fervor de los mas incautos y la lealtad sobornada de los mas codiciosos. !!

  8. Inflation has been always defined as monetary phenomena, as such is clear that is a political decision, when inflation becomes “uncontrolled” the economic theory define as hyperinflation. The example depicted in your note is a very well known book inflation tax example, a very simple case of “helicopter money” through out as budged deficit financing, but ii did not explain how and why the economic theory name it “tax” or better “inflation tax”, even though the diagram shows that the apples are more expensive since government somehow depredate national currency purchasing power. For that, your simple example could mislead the particular way inflation tax occurs in Venezuela. If I have the time today I shall comeback to explain how in a “oil country” where oil revenues are at the sane timen fiscal revenues,. half of government fiscal revenues, could bring us to am scenery of hyperinflation or a unstable inflation tax process and how printing money process is generated, and its product it is not an ordinary inflation but a hyperinflation. This phenomena was already visible just after we understand how Maduro was prepared to finance his huge budget deficit applying the whole power of “the law” for enforcing price repression (scarcity) including exchange controls and keep government finances by printing money. Fiscal deficit at the end of 2012 measured by the broad “restricted public sector budget” was already in the borders of 22% in terms of GDP, with no solution at all, an less government bite the bullet cutting his huge government expenditure, which I guessed was not Maduro’ s option after the 2013 elections. Once Maduro decided for price repression and hiding prices indicators, keeping government -nominal- money demand- well over expected inflation, it was crear that we started a way towards hyperinflation. In an economic environment as it is ours of price repression, control exchange and weak property rights, the parallel dollar it is the best proxy to indicate the bolivar power purchasing parity (PPP), particularly when the currency is perceived as been debased, the results is a hyperinflation. .

  9. Quico, I would distinguish between the inflation tax and the decline in real income. The inflation tax is a tax on people’s holdings of cash and deposits, it is not a tax on income. You could have a higher inflation tax and no decline in real wages, at least in principle. The fact that very high or hyper inflation results in lower real wages is because the economy stops working, the amount of real credit in the economy collapses, uncertainty increases, etc. In other words, the decline in real wages is a by-product of the inflation tax, rather than the tax itself.

    In the case of Venezuela, the effect is amplified by the price controls, which basically squeezes the private sector until it stops producing altogether, as you’ve pointed out so many times in your blog. That’s why real wages are collapsing. But again, none of that goes to the government, it is just because the productive capacity of the country has collapsed.

  10. manon, the inflation tax is also a tax on real income. When price of goods rise your income can buy less so effectively your real income has decreased.

    • Kenny, Im sympathetic to what you’re saying, but strictly speaking it’s not quite right, or at least not always. Inflation is a generalized increase in prices. It’s perfectly feasible to think of a country in which all prices, including nominal wages, increase at the same rate. In this case you can have high inflation but real incomes stay (broadly) constant. This was the case in much of latam through prolonged periods of time, because of wage indexation. However, even then there is an inflation tax, because the tax applies to money in circulation and deposits in the banking system. That’s what Quico’s apple example is about.

      The collapse in real wages in Venezuela is about something different. It’s not that there is a share of people’s income that is being taken by the government. Real wages are collapsing because the supply side of the economy is collapsing. This is caused by the interaction of price controls and inflation, but we should not call it a tax because, unlike the true inflation tax, it does not accrue to the government in any way.

  11. Manon, lets not split hairs over definition. The decrease in real wages due to inflation is also an inflation tax and it does benefit the govt. Part of your purchasing power has gone to the govt via the printed money they hold.

    • Wee, what you are describing is about money in circulation, not wages. Look, I’m not defending the government, and I’m not arguing that the decline in real wages is not a catastrophe. And I’m not arguing that the decline in real wages is not the result of the huge disruptions caused by inflation. What I’m arguing is that no significant part of the decline in real wages (again, due to inflation) goes to the government. It’s not that income is being taxed, it’s that income is being destroyed. Those are two very different things.

      The decline in real wages is the collateral damage that the government, in its infinite ignorance, never foresaw when it deciding to start printing money like no tomorrow. If what you’re arguing were true, the government would be awash with real resources right now. But that’s not the case, real government spending is also collapsing (according to Francisco Rodriguez).

      Now, it could also be the case that the bargaining power of workers has been diminished, so that all else equals, the patronos (including the government) are getting a larger share of value added in the economy. But I don’t think that’s the case. Everybody is seeing its income collapse: workers, capitalists, and the Government.

  12. Hang on there Toro, in a socialist economy you can’t increase prices as you like. What if the government mandates the price of Apples at $2?

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