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Early Inflation Tax Theory and Estimates
Ephraim Kleiman *
Everything of importance has been said before by somebody who didn't discover it.
--Alfred North Whitehead
Those who cannot remember the past are condemned to repeat it.
1. The Rediscovery of the Inflation Tax Concept in the 1950s
Asked to identify the source of the inflation tax concept and the time at which it originated, most economists would probably refer today's inquirer to Milton Friedman's Essays in Positive Economics (1953). In fact, so did Friedman himself (1971, 846) when, returning to the subject nearly two decades later, he opened his article by stating that "it has become common to regard inflation . . . as a tax on cash balances," [End Page 233] citing (in the following order) "Friedman 1953; Bailey 1956; Cagan 1956; Johnson 1967." At first it may seem surprising that Friedman did not date his contribution a decade earlier, the relevant chapter in his 1953 book being a reprint of an essay originally published in the American Economic Review in 1942. But in fact, the passages referring to the inflation tax do not appear in the original article (Friedman 1942), having been, as the author pointed out, added later "to correct a serious error of omission in the original version" (Friedman 1953, 251). 1 In any case, the main topic of this earlier article was not the inflation tax as such, but the inflationary gap and the various ways in which it might be closed. The relevant chapter (like the original piece from which it originates) is actually titled "Discussion of the Inflationary Gap."
In the 1953 book Friedman provided no references to any earlier authorities. He seemed not to have been aware, at the time, of the earlier literature on the subject and of the explicit use there of the term inflation tax. For although the exposition manifests the author's customary analytic sharpness and clarity, the designation of the burden of inflation as a tax seems somewhat tentative: "The price rise imposes, as it were, a tax on the holding of [nominal government] obligations" (1953, 254; italics added); "translation into an explicit tax on cash balances may help" (256); "best of all, we can classify it as a tax payment" (256). 2
It took some time for the term to catch on. Writing two or three years later, Martin J. Bailey similarly speaks of the welfare cost of inflation as being "in effect, . . . a tax on . . . cash balances" (1956, 93). It is true that Phillip Cagan (1956, 77-86) entitles the relevant section of his study of hyperinflations "The Tax on Cash Balances" and [End Page 234] uses this term without any of the above qualifications, although he, too, does not refer to it as an inflation tax. But two well-known attempts to estimate what in effect are, or can be, measures of the inflation tax, Mayer 1959 and Pesek 1960, fail to use the term at all or to make any reference to Friedman or any other earlier writer. In fact, Boris Pesek states explicitly that "as far as I know, only one attempt has been made to empirically evaluate the burden of inflation" (1960, 147), citing G. L. Bach and Albert Ando (1957), who do not, however, refer to the inflation tax as such. 3 Writing a year later, Ralph Turvey (1961) cites Bach and Ando but fails to mention either Friedman or any of his precursors.
The title of Pesek's article is "A Comparison of the Distributional Effects of Inflation and Taxation." One may perhaps speculate that had the term inflation tax been thoroughly internalized by economists by then, he might have used a phrase such as "[effects of] inflation and other taxes." This is even truer of Turvey, whose "Inflation as a Tax in World War II" begs to be retitled "The Inflation Tax in World War II."
Once the term did catch on, however, familiarity with it, or else its self-evidence, came to be taken for granted. Having become a...