Free Liberal

Coordinating towards higher values

Prosperity, Inflation, and Income Taxes

by , Columnist, Free Liberal

During a recent discussion with Paul Jacob, I looked up the two graphs below. They tell an interesting story together. The first one shows how price levels have changed since the founding of the nation, and it’s shocking. Basically, prices didn’t change at all from 1775 until the founding of the Federal Reserve in 1913, then they rose modestly until 1971, when Nixon divorced the dollar from gold. Since then, prices have shot up dramatically.

CPI 1775-2012
US Inflation from 1775 to Present

At first glance, this would seem to be the mark of high inflation, but the second graph tells a different story. It shows the annual rate of inflation throughout our history, and as you can see, the highest spikes all occurred over a century ago. The inflation we’ve experienced since the mid-20th century has been relatively modest, but the one thing we haven’t experienced since the Great Depression is deflation.

In the past, price spikes were always followed by troughs, keeping the average level stable over time. These ups and downs were not pleasant to live through — generally, they represent crises, panics, recessions and depressions. But the upshot is that a person who earned $100 in 1800 could stuff it in a mattress, and it would be worth exactly the same in 1900. Today, your savings loses value over time, so you can’t stuff it in a mattress. You have to either spend it immediately to get the full value or invest it.

Investing is complicated and risky. Most people don’t have the time or inclination to obtain a deep understanding of the subject, so they either screw themselves over or pay for an advisor (who may or may not screw them over). This is a hidden tax on working people. In the 19th century, a worker didn’t have to put any extra effort into holding onto the money they had already earned. Today, we have to keep working to re-earn the money we’ve already earned, unless we choose to spend it and never see it again.

It’s no coincidence that economic mobility has decreased since permanent inflation set in. When you read the stories of self-made men in the old days, they often came to the country as immigrants with nothing but the clothes on their back, worked in a grocery store or something like that, saved up enough to start a factory, and eventually became richer than anyone had ever been in human history. How do you do that on a grocer’s wage? Well, it helps to be industrious, innovative and ruthless, but surely there are just as many people with those qualities working at grocery stores today. The difference back then was that you didn’t have income tax, so you actually got to keep the money you earned, and inflation was offset by deflation over the long run, so again, you actually got to keep the money you earned.

About

Joe Swetnam is into some serious escapades.
Joseph Swetnam majored in English and minored in Economics at George Mason University. He writes about developing economies, immigration and the search for extraterrestrial life. He lives in Alexandria with his wife and two kids.