1) Mechanics: How Inflation Behaves Like a Tax

A. Seigniorage (money creation as revenue)- “Seigniorage is the profit made by a government from the difference between the face value of currency and the cost to produce it.”

When governments finance spending by creating money, they capture Seigniorage—the resources obtained from issuing currency at face value above production cost. The flip side is an inflation tax on the public: as the price rises, the real value of everyone’s money balances falls. Central bank research shows that Seigniorage can be modeled like a tax, with a rate (the inflation rate) applied to a base (real money balances), complete with a Laffer-curve-style tradeoff.

https://www.investopedia.com/terms/s/seigniorage.asp

 B. Debt erosion (“inflate it away”).

Unexpected inflation, such as a sudden increase in the price of oil or a spike in food prices, reduces the real value of fixed-rate nominal liabilities, including government bonds—transferring wealth from bondholders to debtors (not least, the sovereign). A classic quantitative study finds that moderate, unanticipated inflation tends to hurt older, wealthy bondholders and benefit younger, middle-class households with fixed-rate mortgages—while also benefiting the government.

Recent BIS/IMF work also highlights how high public debt can complicate disinflation: if markets suspect fiscal dominance, debt “surprises” can push up long-run inflation expectations, especially in emerging markets—reinforcing the idea that unexpected inflation can function as a budgetary lever.

 C. Tax‑code interactions (the quiet amplifiers).

Even in countries that index parts of the tax code, bracket creep and other unindexed provisions can increase practical tax burdens when inflation is high. Bracket creep refers to the situation in which inflation prompts taxpayers to move into higher income tax brackets, thereby increasing their tax liability. The U.S. indexed major income-tax parameters in the mid-1980s; however, not everything is indexed, and the mechanics (e.g., chained CPI) matter in determining how much creep remains.

A prime example is capital gains: gains are taxed on nominal rather than inflation-adjusted amounts. Over many periods, this can push effective tax rates well above statutory rates—in extreme cases approaching or even exceeding 100% of real gains when price increases account for most of the “gain.”

 2) Who Pays the “Inflation Tax”?

• Savers and holders of nominal assets (cash, fixed-rate bonds, insurance reserves) are the most exposed; the real value of their claims shrinks as prices rise. Empirical work shows that households often underestimate the debt-erosion channel (how inflation benefits borrowers). Still, when informed, they meaningfully revise their wealth and consumption plans—evidence that the redistribution has economic materiality.
• Borrowers with fixed-rate debt stand to gain when inflation is higher than expected, as they repay in cheaper dollars (the classic debtor–creditor transfer documented in U.S. data), offering a potential silver lining in the context of inflation.
• Distribution across income groups is nuanced. Price-level shocks can be regressive when they disproportionately affect categories that low-income households purchase (e.g., energy/food). However, the net welfare effect depends on the source of inflation (supply vs. demand) and on households’ balance sheets. Recent research finds that oil-price inflation shocks tend to be regressive, while demand-driven monetary expansions can be more progressive. The New York Fed likewise stresses the heterogeneous effects across wealth and income groups, ensuring a fair distribution of the inflation tax.
• Foreign holders of a country’s nominal debt can also bear part of the burden when domestic inflation surprises reduce the real value of those claims—a point quantified for the U.S. in the classic redistribution analysis.

3) How Big Is the “Tax”? A Practical Lens

A simple heuristic: the direct inflation tax on real money balances ≈ π × M/P, where π is the inflation rate and M/P is real money holdings. Raise π, and seigniorage revenue first increases, then falls once people shrink their money balances—mirroring a tax‑rate/‑base tradeoff. In modern economies, this channel is modest during periods of low inflation, but it becomes significant when price growth accelerates.

 Beyond money balances, the magnitude depends on how much of the economy’s contracts and taxes are fixed in nominal terms (e.g., bonds, mortgages, capital‑gains rules). That’s why the same headline inflation can imply very different “hidden tax” burdens across countries and periods.

 4) Policy Implications (and Personal Takeaways)

• Monetary credibility matters. Where fiscal positions are strained and institutions are weaker, higher debt raises the risk that markets expect inflation to “carry” part of the budgetary load—making disinflation harder. Strong inflation-targeting frameworks help anchor expectations and reduce the temptation (or perception) of using inflation as a means of taxation.
• Indexation reduces stealth effects. Indexing tax brackets and deductions (as in the U.S. since 1985) or adjusting capital gains taxation for inflation can limit bracket creep and “phantom gains” taxation. Debates over indexing gains continue precisely because inflation can otherwise inflate effective tax rates independent of real income.
• Balance‑sheet management matters. For households and firms, the net effect of inflation depends on asset–liability mix and contract structure (e.g., fixed vs. floating rates). Studies show that when people recognize the debt-erosion channel, they adjust their behavior, underscoring the value of active liability and liquidity management during inflationary periods.

Quote-Milton Friedman

“Inflation is a form of taxation without legislation.”