Text says that taxes are not inflation indexed; hence reducing returns to investors
Is that so?
Taxes are paid in percentage terms. They’re a percentage of whatever constitutes the taxable amount. If the taxable amount is mostly made of freshly printed Quantitive Easing money, its tax will be a percentage of that money. If taxable amount is in gold or kryptonite, the tax will be a percentage of its inflated or deflated value.
Let’s assume the taxable amount is 100 , taxes are 20%, inflation is 3%. Next year’s amounts in today’s dollars are: taxable amount 97, taxes 19.4.
What am I missing? Do I need some sleep ?
What they mean is that the breakpoints for tax rates don’t change with inflation.
Suppose that the tas rate is 20% for income up to $100,000 and 30% for income over $100,000. You make $90,000, so your taxes are $18,000, 20% of your income.
Next year inflation is 30%, so you’re making $117,000. Your taxes are 20% on $100,000 (= $20,000) plus 30% on $17,000 (= $5,100) for a total of $25,100, 21.45% of your income.
So your taxes have increased as a percentage of your income, even though your real income hasn’t changed.
Thanks Magician,
Tax brackets effect is a very rational explanation.
I’m not sure whether the text sees it this way. For life, am going with your explanation. For the test, I’ll just do whatever they want.
Where exactly did you read this?
I’d like to see it in context.
“Corporate income taxes and capital gains tax rates are typically not inflation indexed, so inflation can cut into investors’ after-tax real returns unless share prices fully reflect (through lower prices) the interaction of inflation and taxation”
CFAI. 2015 CFA Level III Volume 4 Fixed Income and Equity Portfolio Management. Reading 24. Section 2. paragraph 3.
To me this is a very weird statement.
Throughout all of your tax related readings, did you encounter such a statement?
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