Principles of Economics- Mankiw (5th) 625

Principles of Economics- Mankiw (5th) 625 - CHAPTER 28 M O...

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CHAPTER 28 MONEY GROWTH AND INFLATION 645 Economists who have studied the tax code conclude that inflation tends to raise the tax burden on income earned from savings. One example of how inflation discourages saving is the tax treatment of capital gains —the profits made by selling an asset for more than its purchase price. Sup- pose that in 1980 you used some of your savings to buy stock in Microsoft Corpo- ration for $10 and that in 2000 you sold the stock for $50. According to the tax law, you have earned a capital gain of $40, which you must include in your income when computing how much income tax you owe. But suppose the overall price level doubled from 1980 to 2000. In this case, the $10 you invested in 1980 is equiv- alent (in terms of purchasing power) to $20 in 2000. When you sell your stock for $50, you have a real gain (an increase in purchasing power) of only $30. The tax code, however, does not take account of inflation and assesses you a tax on a gain of $40. Thus, inflation exaggerates the size of capital gains and inadvertently in-
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