Caracas Chronicles

Hugo Chávez announced yesterday that he was raising taxes … in the middle of a recession.

In announcing a rise in the Value-Added Tax, which hits consumers directly, he also lamented having lowered them in the first place. His main reason? He thought lowering taxes would lower inflation, and they didn’t, so he’s bringing them back up.

The sheer ignorance of such a statement is mind-numbing. As any first-year economics student will tell you, inflation has little to do with the tax rate. Inflation is a direct result of long-term fiscal and monetary variables, as well as consumer expectations. Tax rates exert, at best, an indirect influence on inflation.

Inflation simply means there is too much money following too few goods. Changing the amount of money the government takes from people does not really affect long-term inflation either way, because the government (more or less) immediately pumps that money back into the economy.

Think about it this way: inflation is a continuous rise in the price levels. Why would a one-time change in taxes affect prices in any way other than a one-time change in their levels?

That is not to say that the tax hike won’t affect prices. Higher taxes will increase the cost of pretty much everything you buy, and will cause a temporary bump in the price level. And, as Omar reminded me, it hurts the poor particularly hard, since they devote a higher proportion of their income to consumption.

This, however, is not really inflation, by which we usually mean a sustained increase in prices over several years or, in our case, decades.

Higher taxes won’t alter the long-run inflationary course we are in, just like a drop in the tax rate shouldn’t have been expected to alter it either.

What the tax hike does is create disincentives for people to invest and produce. All other things equal, the higher the taxes, the lower the amount of money people and businesses will have at their disposal to consume, and the longer it will take to emerge from this recession.

I guess that’s what we get for electing a President who never went to college.