The president had some remarks about the inflation this morning, and they sure weren’t encouraging. He mislead with some of them (understating the severity) and basically said the Fed should feel free to start a recession to get inflation under control. This was a fair summary of the nonsense -
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not true at all. my math is correct. Percentages or absolute amounts are irrelevant. The fact is that the government taxes inflation.
If you dispute that, look at the taxes on Ibonds. When you cash them in, you pay tax not only on the fixed rate interest but also on the inflation adjustment, which is supposed to compensate you for the increased price of items due to inflation.
With a 0% real rate as we have it now, when you cash them in you will not be compensated fully for the inflation while you held the bond because of the tax you pay on the inflation adjustment.
as an example, suppose you buy a $100 Ibond and hold it for five years during which inflation is one percent per year or 5% total. When you sell the bond, you will receive $105 but the government will tax the five dollars. if you pay taxes at a 30% rate, you will receive net $103.50. but due to inflation the price of items that cost $100 when you bought the bond now cost $105. So you are behind inflation.
do you claim otherwise? If so please show your math.
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The point is that you are spending the net income, not the gross. I did the math a few posts up, where you earn $100, net $80 after tax, and spend $80. A 10% increase in your gross earnings is also a 10% increase in your net earnings, which matches the 10% increase in your spending.
If you are spending the $100 gross earnings, then yes, a 10% increase will not keep up with a 10% increase in spending, due to taxes. But that’s only because your income wasnt covering your expenses to begin with.
I do not know what you mean by net and gross income. Do you claim that in my example $103.50 after tax net is more than the $105 cost of goods after inflation?
I don’t dispute any of the above, I only dispute your example which was about wages, not I Bond interest. I agree that I Bond holders who pay taxes do fall behind, because for them the after-tax interest earnings do not keep up with inflation. But your example was about wages that keep up with inflation. If pre-tax wages kept up with inflation, then after-tax wages also kept up with inflation.
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Shandril, Glitch and you are just playing word games with the basis for percentages. The basic fact is shown in my Ibond example. Taxes apply to any increases even though part of the increase is to compensate for inflation. for people to break even after taxes the absolute wage increase has to be greater than inflation.
We’re not playing word games, we’ve provided specific examples with specific numbers. Interest income from I-Bonds is not wages! The interest on the I Bond does not INCREASE at the rate of inflation – it increases to match inflation. In other words, if inflation last year was 2% and this year it is 7%, your I-Bond rate (and therefore the difference in income) only went up 4.9% (1.07/1.02). If you pay tax on that interest, you were paying 30% on 2% and now you’ll be paying 30% on 7%. You will always be your-tax-rate behind inflation with I-Bonds.
But your wages would have gone up the full 7% if wages were to keep up with inflation! If you were making $100, you’d now be making $107. If you were making $102, you’d now be making $109.14. Whatever percentage increase you receive pre-tax exactly equals the percentage increase after-tax, and this would even be true at the edge cases because the tax brackets are also adjusted for inflation! So your after-tax income would also go up 7% in this example. And if your spending is up 7%, then you’re exactly where you started, not behind like you keep insisting.
No, it doesn’t.
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[quote]
You will always be your-tax-rate behind inflation with I-Bonds.
[/quote].
this is wrong. The value increases by the fixed rate plus the inflation rate. If the fixed rate is large enough there are some circumstances in which the ibond value increases greater than inflation enough that, depending on your tax rate, the bond value could increase more than inflation after taxes. Interestingly there’s a recent thread on the bogleheads discussing the increase in ibonds value with the fixed rates over the years.
https://www.bogleheads.org/forum/viewtopic.php?f=2&t=369868&newpost=6508861
The fixed rate was large enough in the early years that there’s a substantial after inflation price increase.
Suppose you had purchased a $25.00 I bond (or a $10K I bond) every month starting from September 1998 through December 2021. That would have been 280 purchases, and 220 of them would have been five years or older. I calculated the inflation-adjusted purchase price of each of these bonds (based on a $25.00 I bond) as of January 1, 2022. Then I compared those base prices to the value of these bonds on 1/1/2022. The I bond value goes up every month as it earns interest, and my goal was to compare the bond value to the inflation growth.
…
I bonds purchased in December 2000 or earlier all had more than doubled in their inflation-adjusted fpurchase prices. The I bond purchased in May 2000 is 114.75% above the inflation-adjusted purchase price.
so if the tax rate is less than 50% then the value after taxes increased more than inflation
No, but this was about wages.
So yes, if you are already spending more than you earn, inflation will add more to expenses than it will to your take-home income. But if you are spending your take-home income, the same percentage increase to your expenses as to your income will be equal.
As far as I’m concerned your point is more about semantics than about finance but I’ll bite. What if inflation puts you in a higher tax bracket so your effective tax rate and therefore tax expense increases more than the inflation rate but your wages only increase by the inflation rate? in that case, your tax expense is nonlinear with the inflation rate and your assumptions fail. inflation causes your standard of living to become worse. Show me where I am wrong.
That was pointed out as the one potential variable in literally the first response to your initial comment.
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It is still a valid objection. Shandril assumed that the tax brackets will increase with inflation but that is not necessarily a good assumption in my opinion. The brackets tend to lag inflation. Your argument is based on linearity with inflation and any nonlinearity invalidates it.
You’re grasping for straws. You’re not wrong that some older I Bonds might do better, but the fixed component has been 0 or close to 0 since 2008. Besides, that wasn’t my point. My point was that you’re wrong about wage increases having to be generally greater than inflation to break even. I suppose if you really want to be precise, I’ll grant you the exception for the extremely rare edge cases who just happened to cross into a higher tax bracket that also happens to lag inflation. But generally speaking, for almost everyone the wage increases do not have to be greater than inflation to break even.
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This whole discussion is a sterile academic exercise with no actionable ideas. Your model assumes perfect proportionality, which I’ve shown does not occur. There is no discussion of real world issues such as how well are wages are keeping up with inflation? Or how well does the government’s CPI figure match the inflation felt by middle-class consumers?
It does not tell us how to invest to protect ourselves from inflation. That is why I brought up ibonds. They show that the government does indeed tax inflation and with a 0% real rate as I bonds now have you will always lose inflation adjusted value after taxes.
I am happy that I bought some of the ibonds issued in the early 2000s that had a large enough real rate to overcome the inflation we’ve had since then. That does not guarantee that with higher inflation and inaccurate adjustment of income tax brackets they will also lose inflation adjusted after tax value.
You started this with your whole “that’s not the way I see it.” post. 
It kind of does – make more money! 
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Definitely not an emergency Fed meeting on Monday. It’s closed doors, so only important Fed members can trade based on the outcome
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Your entire premise is that inflation is linear as well, which is also invalid. When inflation rises 10%, all expenses do not go up 10% across the board. The effect on you will depend entirely on what exactly you happen to chose to spend your money on, and that effect could easily be much less than the ‘official’ 10%.
We’re speaking in generalities, there will always be specific circumstances that do not fit.
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Correct. And I think that was the reason for the change from CPI-U to Chained CPI in the tax reform of 2017. When prices go up, consumers adjust their behavior by buying more of the stuff that has not increased too much. If seafood increases 15% and beef increases by 5%, people will start buying more beef than they did before.
Bottom line, it’s definitely not uniform across the basket of goods that determine inflation numbers, and on top of that consumers are not passively still buying the same amount of everything like before.
As far as tax brackets are concerned, they do lag inflation when they get adjusted annually. It evens out however when inflation decreases eventually. And it’ll only apply to the last dollars of taxable income. If your income was right at the limit of the next bracket and increased 7% from inflation, but the IRS increased brackets only by 3% (from lower inflation previous year), only the remaining 4% would be getting taxed at the higher marginal. Going from 22% to 24% marginal on 4% of your taxable income at the limit of this bracket would be about $70 more taxes on a total liability of about $14k (so 0.5% more tax than if you stayed in your current tax bracket). Not negligible but not a big of a hit either.
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interesting article about a country where everything, bank account balances, mortgages, wages, taxes, etc. is indexed to the CPI.
Israelis follow the consumer price index (CPI) like Americans follow baseball scores. Indeed, they pay more attention because more often than not their salaries, their mortgages and a host of other income and expense items are wholly or partly linked to monthly or quarterly inflation.
When inflation was raging into the triple digits in the first half of the 1980s, checking the CPI was a daily pre-occupation. A joke at the time asked whether it was cheaper to take a bus or a taxi from Jerusalem to Tel Aviv. The price in shekels was about the same, but the correct answer was the taxi. Why? Unlike the bus, you paid at the end of the one-hour trip (when the shekel would be worth less than at the start).
The CPI was not invented in Israel, but its utilization has certainly been brought very close to perfection here. With inflation now approaching levels common in Europe and America, the CPI is a less critical part of daily life in Israel than in the past. But the battle to bring inflation down to those levels was neither short nor easy; it took the better part of 15 years - and no one can say for certain that the fight is entirely over or that it was entirely worthwhile.
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And good for people who are short the market.