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Evidently, during the time of revolutionary war, the American colonies were faced with serious financial challenges. In fact, they could not be able to finance the war. This left Americans in a state of financial crisis. At such times, Americans had often opted to print more money to compensate for the enduring scarcity of hard cash. These notes not only helped to ease credit but also facilitated commercial activities (Hall, 78).
It is crucial to agree that American Colonies could not raise enough tax revenue to fully fund their war efforts during the revolutionary war; hence, they resorted to “inflation tax” by printing more cash leading to a financial value loss suffered by holders of cash, fixed-rate bonds, and fixed income provisions.
The subsequent encroachment of inflation diminishes the value of money hence even if people (some) had more money, the value of their cash was meaningless, a phenomenon similar to tax collection, which reduces the total amount of money one is suppose to have.
The congress can decide to print more currency to meet its needs. Central dollars maintained their worth despite the economic strains created by the war. Undesirably, there was no well-organized system put in place to settle the bills. At the beginning of the war, the states imposed a little taxation, although the congress made appeals to make levies payable in continental currency.
The congress together with the states intensified this crisis by producing new currency issues. A total of $191,552,380 had been printed by the congress and another $200,000,000 printed by the states by the end of year 1779 (Hall, 77). In addition, the unavoidable war initiated economic disruptions, which resulted into devastating inflation. The value of American currency declined. Here, the reasons behind printing more money as well as what is actually taxed is analyzed and discussed
‘Inflation tax’ and how what it is
Actually, ‘inflation tax’ is not a legitimate system through which the government gets its revenue; rather, it is a consequence of holding money during the periods of high inflation. Every time more cash is printed by the government, the market gets flooded with money. This eventually increases the rates of inflation. An investor who has securities in form of real estate or any other kind of assets, inflation consequences may be insignificant.
However, for individual holding cash, the value decreases subsequent to inflation. The units of decline in the worth of money are referred to as ‘inflation tax’. If the rate of inflation is 10%, any person who holds one thousand US dollars in cash for one year will have to pay 10% of that cash in taxes. This penalizes people holding money in form of cash (mostly small or medium scale earners according to the economists).
Quite often, low income earners have fixed pays, incomes or allowances and they do not have a means of evading local inflation by moving their assets to other countries. The loss of monetary value resulting from inflation tax is often indicated by the decline in the purchasing power.
When additional money is printed and released to circulate, the government will practically spend less. This indicates the inflation tax mentioned earlier. Actually, printing is the only cost incurred by the government. The cost of manufacturing 50 cents is more than printing each paper of whichever value.
Besides paper, the government only requires a printing press, which they own. In this case, the government is trying to make value from nonentity. This money can then be spent on any extravagant projects by the government without any distress because it is ‘free’. This is how the Americans obtained the extra cash they could use in financing war during revolutionary period.
This situation could be less serious if the printed cash was issued to every individual to spend. According to economists, in this case, everybody would have lots of cash without value. However, the government fails to do that. This money is put into lavish projects or simply given to friends of top government officials. It’s a devious manner of imposing tax on people since it occurs gradually that nobody notices.
Additionally, it is concealed since no legalities are followed. In contrary to other taxes, where an individual is obliged to pay at a certain rate, nobody is asked to remit any cash. Practically, people feel wealthier since there is increment in their wages or house costs and they have even more cash but with very low value. Inflation occurs so covertly since there are no laws to be either passed or voted down. However, inflation normally advances the financial position of persons who have unresolved fixed interest obligations such as credits and loans.
Why government impose inflation tax
Just like any other kind of tax, the government levies inflation tax to cater for its expenditures. Rather than increasing tax rates or borrowing money from other federal financial agencies to raise enough cash, the government opts to print more money to afford goods and services. As the amount of money in circulation increases comparative to creation of goods and services, costs also rises. Families and corporations are left poorer since they now have less power to purchase with their available cash.
An individual can easily evade inflation tax by just avoiding holding cash. According to economic theories, there is a peak inflation rate. At this rate, the amount of inflation tax income gets to the maximum point. Any rate above this maximum rate causes the amount of cash held to decline to the extent that tax income obtained from the inflation tax starts to reduce its buying power.
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If the inflation rates are low, corporations and households find it easy to pay for the inflation tax because they consider it essential cost of appreciating the suitability of holding money in cash (Steuerle 91).
There are extra ways in which inflation tax can help the government to make money. One of the means of gaining surplus tax incomes is by causing tax payers to pay more taxes. Inflation tax as well shrinks the actual, inflation attuned sum of debt owned by the government. Generally, there are no systems or even extra tax collectors required to gather the inflation tax.
Without inflation tax, an individual having $1000 in a reserve account netting an interest of $30 per year, gets $30 since the actual savings rise. However, whenever there is an increment in rates of costs by 6%, then the actual buying power of the reserve amount, $1000, is declining and the interest cannot be able to completely pay for this.
Taking inflation into consideration, there will be a deficit since the purchasing power will have declined in the subsequent year (McConnell 87). Thus the account holder will have suffered a loss of some amount. Yet, the tax regulations do not take into account the influences of the actual varying actual values. In this way the account holder find himself paying taxes, even without factual income.
Currently, there are several options of raising cash by the government than there were during revolutionary period. Banks, financial institutions and financial markets lets the government to borrow cash without degrading their money. Since the ownership of resources is transferred to the public sector, this liability is paid by somebody. If more cash is borrowed by the government, higher rates of interest will soften and higher rates will not be felt.
The borrowing by the government is one of the numerous issues affecting interest rates. Since interest rates influence other variables like savings and also considering that cost of bonds varies inversely with rates of interests, it is quite difficult to ascertain accurately persons affected by the government shortfall (Mconnel et al. 87).
When governments combine different regulations for expenditures and taxes, they can easily induce inflation. Nonetheless, when this takes place, every so often political business persons enlighten the public of the harmful effects of inflation and promise to implement policies to stop this crisis. Therefore, the selfishness theory of the regime is constant with inflation rates or steady prices. The incapacity of this particular theory to provide a strong forecast is a weakness in itself (Tanzi 102).
By increasing the inflation rate, the government also believes that it will improve trade equilibrium of the state by generating more exports with low value currency. This also declines imports. Larger fractions of the inflation tax also affect foreign holders of permanent debts in the low value currency.
Taxation imposed on creditors is associated with concurrent transferals to borrowers. This decreases their debt liability. If wealth is transferred to individuals who will expend it, an inflation tax can be able to stimulate additional rise in the actual economic growth.
According to those opposed to this taxation, it has no any accord or agreement. The government simply raises the tax burden on people with no any form of jurisdictive endorsement (McConnell 52). There is no even any public statement or declaration of proliferation of taxes.
Detractors also mention the serious negative impacts of inflation on low income earning citizens. Economists appeared to have identified the negative influences of inflation tax several years back. However, very little consideration was given to it till the 20th Century, when printing paper cash started taking a lead in the financial systems.
Whenever the government prints more money and gives out credit, they simply raise the quantity of money available in the economy. In most cases, this is done when there is financial crisis in the country like during period of American Revolution war. This normally results into inflation that affects the poorer most since they are more likely to hold their money in form of cash.
According to economists, increasing paper money causes a decline in the value of cash, implying low purchasing power. This is because increasing the available cash in circulation also increases costs. Therefore, even though an individual earns more cash, only same amount of materials can be afforded.
Unfortunately, the amount of savings also declines since the worth of money is reduced. In conclusion, printing more cash does not make people wealthier. The best way to make citizens of a country richer is producing more goods in a proficient manner. This will not only help to reduce the costs of commodities but will also result into economic growth.
Hall, Robert. Inflation: Causes and Effects. Chicago, CHI University of Chicago press, 1994.print
McConnell, Brue. Macroeconomics. New York: McGraw-Hill, 2012. Print.
Steuerle, Eugene. Studies of Government Finance. Washington DC: Brookings Education press. 1985. Print
Tanzi, Vito. Taxation, Inflation, and Interest Rates. Washington, DC: international Monetary Fund. 1984. Print.