Analysis: Wealth tax should not be a stealth tax

No taxation without legislation.


By Allister Heath, May 11, 2011
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It was Milton Friedman, the late lamented economist, who described inflation as taxation without legislation. How right he was. Over the past year, the British public has suffered a national pay cut of around 2.5 per cent, becauseprices are rising at a much faster rate than incomes. The result has been a secret, giant act of redistribution from savers (whose wealth is being eroded as the purchasing power of sterling declines) to borrowers (the value of whose debt is gradually being cut in real terms).

Had the government passed a law in Parliament to take money from people's bank accounts to help pay down their neighbours' mortgages, overdrafts and credit card bills, there would have been outrage. Had the government decreed a partial default on the national debt, the financial markets would have erupted in anger.

Yet because this process is happening on the sly, without any discussion, hardly anybody is batting an eyelid - even though, once again, the prudent are being mugged to bail out the imprudent. Inflation is not just taxation without legislation: it is also the stealthiest of all taxes. Slowly but surely, sterling is being debased, with severe consequences.

Despite all of this, there are many in Britain today who have gone soft on inflation. Employers' groups and many firms are lobbying for interest rates to remain as low as possible for as long as possible, seeking to portray what is indisputably a massive and permanent rise in inflation as minor and temporary. The government is also secretly happy - cuts in public spending will be easier to make. And of course, there are some benefits as well as costs to inflation.

The problem is that the latter are much greater than the former, and that there is no such thing as a controlled burst of beneficial price rises. Once the inflationary genie is let out of the bottle, it soon turns into a wealth-devouring monster that can only be slain with the sustained and painful imposition of much higher interest rates.

The speed at which savings are being confiscated is astonishing. Inflation at 5.5 per cent per year will raise the price level by 30.7 per cent over five years: this reduces the purchasing power of £1 by 23.5 per cent, to 76.5 pence. Over 10 years, inflation at 5.5 per cent raises the price level by 70.8 per cent and reduces the purchasing power of a pound by 41.5 per cent, to 58.5 pence.

One reason why there has not been more of public outcry at the return of inflation in the UK is that the balance of power between savers and borrowers has changed dramatically in recent years. The latter have seen their influence diminish; the former have gained clout. In part, this is because savers were given a huge fillip when banks such as RBS and Northern Rock were bailed out at the height of the financial crisis. Debtors now probably think it is their turn for a handout. But the real reason for the shift is that Britain went on a debt-fuelled spending binge over the past 15 years or so, and that the political power of debtors is therefore commensurately greater.

Another Friedman saying was that inflation is always a monetary phenomenon, by which he meant it is caused when too much money chases too few goods, services and assets. But it is also fair to say that inflation can also be a fiscal phenomenon - when a country's debt burden becomes too large, the temptation for the state to start printing its way out of trouble almost inevitably becomes too strong to resist. It doesn't really matter whether or not the central bank is independent. If a government wants to take money from one group of people and give it to another, it should say so explicitly. If it wishes to default on the national debt, cut wages or reduce public spending in real terms, it should do this openly. It shouldn't use the Bank of England to do its dirty work. Inflation violates contracts and property rights; it creates uncertainty and mistrust. Its costs - economic as well as moral - are too great. Britain desperately needs a renewed commitment to sound money - and a new war on inflation.

Allister Heath is the editor of City AM

    Last updated: 5:00pm, May 11 2011