Consumption-Based Private To Public Redistribution During Inflation

Abstract

Neglecting the redistributive effects of a progressive income tax in an inflation, current literature in macroeconomics and public finance offers two contradictory explanations of consumption-based redistributions to the government during inflation. One explanation, the consumer illusion approach, alleges the redistribution process to be totally dependent on consumers failing to distinguish between real and money income. This approach alleges, moreover, that the monetary sector can be ignored as a constraining element in the redistribution process. The alternative, inflation tax on money analysis, sees a redistribution occurring regardless of the above illusion, the process constrained entirely by the monetary sector. Despite the rather long life of each explanation, the contradictions have never been recognized, let alone resolved, in the literature. This paper does both. We show the consumer illusion mechanism, as the literature explains it, to be subject to internal inconsistencies which are fatal. Once corrected for these critical defects, the perspective on the redistribution process which remains is shown to be identical to that of inflation tax on money analysis.