7.12 ndian onom
making consumption expenditure fall. Exact benefits borrowers. This benefit, however, depends
opposite happens once prices head downward. upon the contemporary levels of fiscal deficit and
On the other hand inflations makes the total national debt.
‘investment’ expenditure increase as a result In the case of a government incurring high
of decreased cost of money/finance (inflation fiscal deficit (increased borrowing, printing
brings benefit to borrower—known as ‘inflation currency), inflation functions as a tax, i.e.,
premium’). In times of price fall just opposite inflation tax via which the government fulfils its
happens. expenditure by cutting down the expenditure and
consumption of the people.
8. On Tax
On tax structure of the economy, inflation creates 9. On Exchange Rate
two distortions: With every inflation the currency of the economy
(i) Tax-payers suffer while paying their direct depreciates (loses its exchange value in front of a
and indirect taxes. As indirect taxes are foreign currency) provided it follows the flexible
imposed ad valorem (on value), increased currency regime. Though it is a comparative
prices of goods make tax-payers to pay matter, there might be inflationary pressure on
increased indirect taxes (like cenvat, vat, the foreign currency against which the exchange
etc., in India). rate is compared.
Similarly, due to inflation, direct tax
(income tax, interest tax, etc.) burden of 10. On Export
the tax-payers also increases as tax-payer’s With inflation, exportable items of an economy
gross income moves to the upward slabs gain competitive prices in the world market. Due
of official tax brackets (but the real to this, the volume of export increases (keep in
value of money does not increase due to mind that the value of export decreases here) and
inflation; in fact, it falls). This problem thus export income increases in the economy. It
is also known as bracket creep—i.e., means export segment of the economy benefits
inflation-induced tax increases.39 Some due to inflation. Importing partners of the
economies (as in the US and many economy exert pressure for a stable exchange rate
European countries) have indexed their as their imports start increasing and exports start
tax provisions to neutralise this distortion decreasing (see the next point).
on the direct tax payers.
(ii) The extent to which tax collections of 11. On Import
the government are concerned, inflation
Inflation gives an economy the advantage of lower
increases the nominal value of the gross
imports and import-substitution as foreign goods
tax revenue, while real value of the tax
become costlier. But in the case of compulsory
collection does not compare with the
imports (i.e., oil, technology, drugs, etc.) the
current pace of inflation as there is a
economy does not get this benefit and loses more
lag (delay) in the tax collection in all
foreign currency instead of saving it.
But governments get an advantage on their 12. On Trade Balance
interest burden, on their borrowings as inflation
In the case of a developed economy, inflation
39. Samuelson and Nordhaus, Economics, p. 674. makes trade balance favourable, while for the