Inflation's decline -- its impact on wage-earner, taxpayer, investor
Washington — The sharply reduced inflation rate the United States is now enjoying will have a pronounced effect on consumers' pocketbooks and bank accounts, economists say.
While it lasts, the lower inflation will cut individuals' tax bills, boost the value of pensions and wages, and sweeten the return on savings and investments.
''Taxpayers, people on fixed incomes, investors, and workers are all beneficiaries of the lower rate of inflation we now enjoy,'' says Martin Feldstein, chairman of the President's Council of Economic Advisers.
Of course, lower inflation does not help everyone. For instance, some individuals have purchased homes, expecting prices to keep rising rapidly. They were hoping to repay loans with cheaper, inflation-eroded dollars.
''It is basically (borrowers) who might suffer'' from a sharp reduction in inflation, because their investments won't rise in value as fast as they expected, says Ted Gibson, senior economist at Crocker National Bank in San Francisco.
Reduced inflation was evident in March, when consumer prices rose only one-tenth of 1 percent, after adjustment for seasonal factors. During the first three months of the year, prices were rising at a rate of four-tenths of 1 percent, the slowest climb for any quarter since 1965.
Individuals are starting to adjust to the reduction in inflation. The perception of more stable prices ''is beginning to sink in,'' says Sandra Shaber , senior economist with Chase Econometrics, a economic forecasting firm.
One sign of this awareness is that consumer confidence jumped in March by the largest amount in nine years, according to the Conference Board, a business research organization.
And not only were consumers more confident about their present economic conditions, but their expectations for the future were at the highest level in the survey's history. For example, some 23 percent of the 5,000 households surveyed thought their family incomes would rise in the next six months.
For the year as a whole, however, lower inflation is not likely to help real, or inflation-adjusted, household incomes as much as it has in the past couple of months. ''We know that zero inflation cannot last forever,'' President Reagan told a news conference Friday.
Economists agree. ''The current numbers probably understate the underlying inflation rate,'' Mrs. Shaber notes. The current consensus among forecasters is that inflation will rise about 3.5 percent for 1983 as a whole.
One reason the inflation rate will climb somewhat is that energy costs will probably rise somewhat, says Crocker Bank economist Gibson. The imposition of a 5-cent-a-gallon increase in federal gasoline taxes in April and an end to the rapid decline in world oil prices will edge energy prices upward, he says.
And food prices have already started to climb because of bad weather in crop-production areas in California. In March, food prices rose six-tenths of 1 percent, the biggest increase among the seven major price categories the government tracks.
The government's program to pay farmers for not planting crops ''is going to have an effect on food prices six or nine months down the road,'' adds Robert Wescott, an economist at Wharton Econometric Forecasting Associates.
Still, the 3.5 percent inflation rate expected for 1983 is a major improvement over 1981's 8.9 percent hike in prices, and compares favorably with the 3.9 percent jump in prices during 1982.
The reduction in inflation will be clearly felt in consumers' tax bills, since inflation forces individuals into higher income brackets, which means higher taxes.
Consider a family which had a 1980 income of $20,000 and managed to keep its income rising enough to just offset inflation through 1984. If inflation had continued at its 1980 rate of 12.4 percent, the family would have ended up paying 19 percent more federal income tax than under the inflation rates now expected through 1984, Mr. Feldstein recently told the Congressional Joint Economic Committee. And that 19 percent hike is after adjusting for the fact that the taxes would have been paid in inflation-cheapened dollars.
Tax brackets are slated to be indexed for inflation in 1985, if Congress does not abandon the plan before then. ''But a family would never make up for the bracket creep during 1980 through 1984,'' Mr. Feldstein notes.
Slower inflation also eases the plight of individuals living on fixed incomes such as private pensions. For example, if inflation had continued at its 1980 rate through 1984, prices would be 27 percent higher than the Reagan administration now expects them to be. So a family with a typical fixed income of $15,000 would have found itself over $3,200 worse off in purchasing power than it is now likely to be, Mr. Feldstein claims.
Statistics suggest that, after an initial delay, workers find their real (inflation-adjusted) incomes rising during periods of declining prices. One reason for this is that salary hikes are not eaten up by inflation. And, again, there is less chance of being pushed into a higher tax bracket.
From the start of 1978 through the third quarter of 1981, real wages fell as inflation continued to rage. But in 1982, with inflation on the decline, real wages rose over 2 percent. In January 1983, for the first time in two years, real wages were higher than they had been a year before.
Of course, the reduction in inflation that helped make higher real wages possible was achieved at a terrible cost in unemployment. Lower inflation improves real income ''only for those who still have sources of income,'' Mrs. Shaber notes.
Even though interest rates on savings often fall as inflation declines, the real return on savings and investments can improve because of tax consequences. For example, dollars held in a money-market account now might return 8 percent interest. So a person in a 30 percent tax bracket would get to keep 70 percent of that interest, or 5.6 percent. After subtracting a 4 percent inflation rate, the real return would be 1.6 percent.
By contrast, if inflation were 10 percent and a person earned a 4 percent return, his pretax interest rate would be 14 percent. After tax at 30 percent, he would keep 70 percent of the return, or 9.8 percent. So the rate he earns is less than the rate of inflation, Feldstein notes.
Nevertheless, a lower inflation rate leaves much to be desired, notes Sen. Roger Jepsen (R) of Iowa, chairman of the Congressional Joint Economic Committee Chairman. ''Falling inflation does not put any money in your pocket - it just takes it out more slowly.''