Taxes are inherently disinflationary.

Today’s inflation is a real concern⁠—it is running too high and is reducing households’ purchasing power. But linking fiscal policy decisions about the proper level of taxes and spending in the medium and long run to today’s inflation makes little sense. Even worse, many of these policymakers cast both the tax increases and the spending increases as potentially inflationary. This is not just unwise—it is simply economically innumerate.

In this post, we make the following points:

The direct effect of tax increases is to slow the pace of aggregate demand growth, not increase it. This means that the tax increases included in proposed fiscal policy packages are disinflationary, full stop.

In the medium to long run, the investments included in proposed fiscal policy packages will reduce costs that American families face for a number of crucial goods and services, from health insurance premiums and prescription drugs to energy costs and child and elder care.

A fiscal policy package that expands social insurance and public investments⁠—and finances these by progressive tax increases⁠—is essentially aiming to meet pressing social needs with a moderately larger footprint of the public sector in the economy.

Currently, the U.S. public-sector footprint is extremely small compared with other advanced economies, to the detriment of the economic security of U.S. families.

There is nothing inflationary about this larger public footprint. Since the pandemic recession began, inflation has actually run more slowly in countries with higher spending as a share of GDP.

Generally speaking, fiscal policymakers are uniquely ill-suited in the short run to restrain inflation that has been caused by excess growth in aggregate demand⁠—this fact is why the Federal Reserve is generally given primary responsibility for this task.

However, the inflation of the past year has largely not been driven simply by excess growth in aggregate demand, meaning there were some tools that fiscal policymakers could have deployed to help restrain price growth, but they were not taken up. A quickly enacted excess profits tax, for example, could have restrained the dominant source of price growth in 2021.

Taxes—even highly progressive ones—are disinflationary

The tax increases that have been proposed as part of various fiscal policy packages in recent months are extraordinarily progressive, raising the vast majority of their revenue from high-income households (or corporations). Because high-income households save so much more out of a marginal dollar of income than they spend, this means economy-wide spending and aggregate demand are affected only slightly by tax changes on these households. But, a slight effect doesn’t mean no effect: Raising taxes on high-income households will unambiguously slow aggregate demand growth.

All else equal, slower aggregate demand growth puts downward pressure on inflation. This is true even if one does not believe that today’s inflation is largely a function of aggregate demand growth rising too fast relative to the economy’s underlying productive capacity (“too much money chasing too few goods”). In short, policymakers arguing against the tax provisions of proposed fiscal policy packages on the basis of today’s too-high inflation are demonstrating extreme economic innumeracy.

Proposed public investments would help reduce costs and future inflationary pressures

While tax increases are disinflationary, it is true that public spending increases are inflationary, all else equal. But context is crucial here. For one, the spending in these proposed packages will hit the economy gradually over time. These packages are not stimulus packages like the American Rescue Plan (ARP), which injected huge amounts of spending into the economy all at once by design to stabilize a sinking economy. Instead, the fiscal packages being debated today are largely about public investments—measures that will expand the economy’s supply side. These capacity expansions will tamp down inflationary pressures as they come to fruition.

An obvious example is the proposed investments in child and elder care. These types of investments have been shown to significantly boost women’s labor force participation rate, and this labor force growth is a key addition to the economy’s capacity. For those who think today’s inflation problem is “too much money chasing too few goods,” expanding the economy’s supply-side capacity enables more goods to be produced, hence tamping down inflationary pressures.

Of course, by far the most pressing investment need facing the U.S. and global economies today is reducing carbon emissions to slow climate change. If climate change proceeds under the “business-as-usual” scenarios wherein emissions are unconstrained by policy decisions, the results for the economy’s supply side are incredibly damaging. Climate-driven supply-side contractions moving forward will be extremely inflationary (not to mention causing huge human misery often quite hidden from macroeconomic aggregates).

Finally, many of the provisions in the fiscal packages under debate will reduce some of the most salient costs harming U.S. households. High-quality child care, for example, is extraordinarily expensive for most families today. Subsidies that cap its cost will provide huge relief to families. In the jargon of economists, this actually is not a reduction in “inflation” per se. But in the minds of the vast majority of the public, reducing the costs that pressure their family budgets is likely every bit as good as a reduction in “inflation.”