Front Page Titles (by Subject) 6.8.: Inflation and Income Tax Revenue - The Collected Works of James M. Buchanan, Vol. 9 (The Power to Tax: Analytical Foundations of a Fiscal Constitution)
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6.8.: Inflation and Income Tax Revenue - James M. Buchanan, The Collected Works of James M. Buchanan, Vol. 9 (The Power to Tax: Analytical Foundations of a Fiscal Constitution) 
The Collected Works of James M. Buchanan, Vol. 9 The Power to Tax: Analytical Foundations of a Fiscal Constitution, Foreword by Geoffrey Brennan (Indianapolis: Liberty Fund, 2000).
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Foreword and coauthor note © 2000 Liberty Fund, Inc. © 1980 Cambridge University Press.
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Inflation and Income Tax Revenue
Throughout this chapter, we have focused on the direct effects of money creation as a revenue device in its own right. We have ignored the possible indirect effects of inflation on revenue arising from its intersection with income taxation, a topic that is probably more familiar to mainstream public-finance specialists than those we have dealt with here. These indirect effects are of two types. The first and most obvious is that inflation, in the absence of any countervailing measures, increases real rates of progressive income taxation by pushing taxpayers into higher tax brackets.
To the extent that these apparently gratuitous effects of inflation are less conspicuous than explicit tax-rate increases, it follows that inflation presents government with a discreet and unobtrusive means of raising additional revenue. Such a possibility hardly fits neatly into our analytic framework. We have not introduced “fiscal illusion” at any other point: the entire discussion so far has proceeded in the bright glare of full taxpayer rationality. Leviathan is unashamedly exploitative, and taxpayers are completely aware of this. The revenue-maximizing rates for a given degree of progression will be arrived at, and beyond some point at least, increases in those rates can only reduce revenue. Discussion of this problem properly belongs to an analysis of fiscal illusion, and we have not included any such analysis in this book for obvious reasons of economy.16
The second aspect of the interaction between inflation and income taxation does not depend on progression at all, but rather on the extent to which income taxation, by virtue of taxing property income as well as labor income, involves an element of wealth taxation. As mentioned in Chapter 5, the extent of this tax on wealth can be increased by increasing the rate of inflation, given that nominal property returns are taxed. For example, if the rate of inflation is 9 percent and the real rate of return 3 percent, a nominal income tax rate of 25 percent becomes equivalent to an effective rate of 100 percent on property income. By setting the rate of inflation at the required level, it becomes possible for a single income tax to obtain maximum revenue both from labor income and from wealth without any overt discrimination, even though the demand elasticities between leisure and effort on the one hand, and between present and future consumption on the other, are quite different. This possibility would not of course be present if the “income tax” were levied solely on consumption expenditure.
[16. ] For a more lengthy treatment of this topic by one of the authors, see James M. Buchanan, Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967), chap. 10.