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By Root 363 0

in 1985, but some of the effect remains because indexation has not been extended to all elements of the personal income tax structure. In a similar way, corporate income is artificially inflated by inadequate allowances for depreciation and other costs. On the average, prior to the mid-1980s, if income rose by 10 percent simply to match a 10 percent inflation, federal tax revenue tended to go up by more than 15 percent—so that the taxpayer had to run faster and faster to stay in the same place. That process enabled the president, Congress, governors, and state legislatures to pose as tax cutters when all they had done was to keep taxes from going up as much as they otherwise would have. Each year there was talk of cutting taxes. Yet there has been no reduction in taxes. On the contrary, taxes, correctly measured, have gone up—at the federal level, from 22 percent of national income in 1964 to 26 percent in 1978 and 28 percent in 1989, despite the Reagan tax cuts in 1981 and the Tax Reform Act of 1986; at the state and local level, from 11 percent in 1964 to 12 percent in 1978 and 14 percent in 1989.*

A third way that inflation yields revenue to the government is by paying off—or repudiating, if you will—part of the government's debt. Government borrows in dollars and pays back in dollars. However, thanks to inflation, the dollars it pays back buy less than the dollars it borrowed do. That would not be a net gain to the government if in the interim it had paid a high enough interest rate on the debt to compensate the lender for inflation. For the most part, it has not done so. Savings bonds are the clearest example. Suppose you had bought a savings bond in December 1968, had held it until December 1978, and then had cashed it in. You would have paid $37.50 in 1968 for a ten-year bond with a face value of $50 and would have received $64.74 in 1978, when you cashed it in (because the government raised the interest rate in the interim to make some allowance for inflation). But by 1978 it took $70 to buy as much as $37.50 would have bought in 1968. Yet not only would you have gotten back only $64.74; you would also have had to pay income tax on the $27.24 difference between what you received and what you paid—in effect, you would have ended up paying for the dubious privilege of lending money to your government.

You would have done better in the 1980s, after inflation was reduced and the Treasury adjusted the interest rate so that it more fully reflected inflation. Suppose you bought a Series EE U.S. Savings Bond in May 1981, held it until May 1991, and then cashed it in. You would have paid $25 in 1981 for a ten-year bond with a face value of $50 and would have received $56.92 on cashing it in. By 1991 it took about $41.38 to buy as much as $25 would have bought in 1981. So you would have received $15.54 in purchasing power as interest, an apparent real rate of return of 3.24 percent a year. However, that would not have been a clear gain because of the income tax due on the $31.92 difference between what you received and what you paid. Depending on your income level, the tax would have eaten up between one-third and two-thirds of the meager real return. All in all, you would have earned between 1 percent and 2 percent a year in real terms for letting the government use your money for ten years. Hardly a princely return, but certainly better than ending up in the red.

Although the federal government has run large deficits year after year and its debt in terms of dollars has gone up, because of inflation the debt has gone up far less in terms of purchasing power, and for a time it actually fell as a percentage of the national income. In the decade from 1968 through 1980, when inflation was accelerating, the federal government had a cumulative deficit of more than $340 billion, yet the debt amounted to 32 percent of national income in 1968, 25 percent in 1980. In the years from 1981 through 1989, when inflation was coming down, the cumulative deficit totaled more than $1,400 billion and the debt climbed to 45 percent of the