Saturday, March 1, 2008

Inflation and tax

On the other day, I was having one of those small talk moments with my landlord. He complained that he should have a tax break because he has no kids. It should not be his responsibility to fund the local school system through his tax dollars. And somehow, his extra dollars saved in tax can help lower the inflation.

As interesting as his claims sound, nothing will change in the big picture. Giving tax breaks to taxpayers with no child is as same as taking $5 from your left pocket (government spending) and putting it in your right one (consumption and investment). Overall nothing did change in GDP.
GDP = Consumption + Investment + Government Spending + (Exports – Imports), or
GDP = C + I + G + (X-M)


If you assume the government spending remains the same then my landlord is also wrong. There's an increase in GDP, hence inflation and increase in money supply.
velocity * money supply=real GDP * GDP deflator
velocity: stays stable in the long run


However, his tax dollars did not went to waste up to some extend. Better funded schools tend to be better schools, therefore increases the housing prices in that district.

ps. I will leave the US school system for a further discussion.

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