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An inflation tax is the amount of economic suffering that occurs when the implementation of some type of expansionary monetary policy causes the value of cash and cash equivalents to decrease. This situation results in what amounts to a hidden tax that effectively reduces the buying power of consumers, especially those who tend to maintain a larger portion of their income in cash. Until the marketplace adjusts to the new policy, that buying power remains somewhat subdued, and can cause hardship in many households, especially those that are associated with the lower and lower middle economic classes.
The implementation of new money policies usually takes place as a means of moving the economy in a direction that is anticipated to be in the best interests of everyone in the long run. During the early stages of this new policy, certain economic groups are likely to suffer more than others. That suffering, identified as an inflation tax or a regressive consumption tax, is not a tax in the sense that a tax agency assesses some amount that must be forwarded to that agency. Instead, an inflation tax describes the effect of the new policy on certain classes of consumers who find that their cash assets are being strained or taxed by the new economic climate.
Inflation tax tends to develop when a government utilizes a process known as seignorage to bring about economic change. In this scenario, central banks will increase the printing of bank notes and issue additional credit as the first steps in reversing an unfavorable trend in the economy. As the marketplace reacts to those changes, inflation begins to occur. That inflation then reduces the buying power of cash for a period of time, until income levels are adjusted and the overall buying power of consumers is restored. Care is usually taken in exactly how this strategy is utilized, since continuing the trend for too long can result in creating economic conditions that are worse than the condition that the government was attempting to reverse.
While there are exceptions, consumers who tend to rely on cash and cash assets to manage household expenses are most likely to be significantly affected by the implementation of a new policy. This normally includes significant segments of consumers whose income levels are considered low or lower middle class in many western nations. By contrast, consumers in the upper middle and upper economic classes tend to rely less on cash and cash assets for their economic stability, and are not affected as severely by the new monetary policy, resulting in less of an inflation tax on their purchasing power.