NO, TAX CUTS DO NOT CAUSE INFLATION
Tax cuts do not cause infl ation. The claim that they do, made by the Oklahoma Policy Institute (OPI) in a recent article, was put on my radar because it was retweeted by state Senator Julia Kirt (D-Oklahoma City). The article stated, “[i] f anything, pouring more money into the economy in the form of across-the-board and untargeted tax cuts would likely make inflation worse.” This claim lacks sound economic reasoning and is inconsistent with the rest of OPI’s tax and budget proposals.
As a threshold matter, there is a misunderstanding of what inflation is. Most people think of inflation as a rise in prices–what I will term “price inflation.” But this price inflation is the result of inflation, which has historically been defined as an increase in the money supply. While state officials often talk about “inflation relief,” the reality is state lawmakers are incapable of affecting the money supply. That power falls to the federal government–namely, the Federal Reserve. That reality, however, does not mean tax cuts don’t provide real benefits to the economy.
It turns out consumers are not inclined to spend money the same way government spends money. For example, left to my own choices, I would not pay for OETA (just like I don’t pay for cable), but the state takes my taxes and spends it on OETA anyway. Tax relief allows individuals to spend money on things they actually want through voluntary exchange, as opposed to the state, which takes money by force to spend it on things they otherwise wouldn’t. When money is spent through voluntary exchange, more consumer wants and needs are satisfied.
It turns out that government taxing and spending is bad for the economy. Not only does every dollar paid in taxes take from productive individuals, it also distorts the market process. For every dollar the state pays for fuel, a dollar is taken out of the free market where it would have been spent on consumer wants rather than government wants. But it gets worse. That dollar spent on fuel for the government also bids up the price of fuel for individuals and businesses. Allowing people to keep more of the fruits of their labor improves outcomes as goods and services are directed toward consumer wants rather than government wishlists.
But let’s assume, for the sake of argument, that price inflation would result from a reduction in the income tax. What is the alternative? OPI suggests “targeted” tax relief such as expansion of the Sales Tax Relief Credit.” It is unclear how this form of tax relief would not also lead to price inflation. The position seems to be that tax cuts for everyone are inflationary but not tax cuts for certain low-income people. But this is incoherent and actually misses one of the best reasons to cut taxes and cut them now.
As progressives have told us for years, tax relief for the poorest individuals gets spent on consumption. For Keynesians, this is great, as they believe consumption is what drives the economy. And frankly, I think everyone should get tax relief, so I’m not bothered by the likely increase in consumption from these folks. But Say’s Law tells us that production must precede–and is the source of–demand. It is production–not consumption– that creates wealth. Tax breaks for the wealthy and for businesses encourage saving and investment, which is not only necessary for consumption but can help in recessions. I believe a recession–and possibly a deep one–is coming. One thing that can help get the economy back to normal would be investment in production. That is the primary reason to cut taxes.
It would be great if state officials would stop acting like they can have any real effect on inflation. They can’t. The money supply is wholly controlled by the federal government–specifically, the Federal Reserve (which should be abolished). But tax cuts in the form of lower marginal rates can spur economic growth as more people save and invest in productive activities.