Inflation Accounting

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Adjusting Taxes for Inflation
By Victor Thuronyi

If we could but learn to number our days...we should adjust much better our other Accounts. —Abraham Cowley (1667) Most countries do not adjust their tax system for inflation, or do so only partially. When inflation reaches significant levels, however, its effects on the tax system cannot be ignored. The best remedy is to bring inflation under control; when this is not possible, it is often desirable to adjust the tax system to inflation in some manner. Inflation has come down around the world in most countries as of the time of this revision (2012), and so inflation adjustment of taxes might not be as pressing as it was previously. Even at low inflation rates, however, the distortions caused by inflation can be significant. Even if one is not contemplating to adjust taxes for inflation, it is important for tax policy analysts to understand the issues raised by inflation adjustment, and so this chapter remains relevant for tax policy analysis in all countries. For the few countries with substantial inflation rates, the material here can be used in making decisions on whether and to what extent tax rules should be adjusted for inflation. This chapter discusses mechanisms of inflation adjustment for different taxes.1 For taxes other than the income tax, the method of adjustment is relatively simple as a conceptual

Note: This chapter was first published in 1996. This revision was done in 2012, for which the author is grateful to Philippe Stephanny for research assistance. The initial research for this chapter was done under a Fulbright Foundation grant for travel to Argentina, Brazil, and Chile in the summer of 1990. The author is grateful to the Fulbright Foundation and to a number of tax professionals in the three countries who generously gave of their time, including staff of the Centro Interamericano de Estudios Tributarios (Jorge Gonzalez Cano and Juan Carlos Gomez Sabatini) and Enrique J. Reig (Buenos Aires). Helpful comments were also received from Yishai Beer, Isaias Coelho, Richard Gordon, Charles McLure, John Norregaard, and Wayne Thirsk. 1 There is a large body of literature on inflation adjustment of taxes. To try to cite it all would be beyond the scope of this chapter, which focuses on global adjustment along the lines of that adopted in Latin America, which most of the literature in English does not directly consider. For a survey and analysis of inflation adjustment in Latin America, see Organización de los Estados Americanos, Inflación y Tributación (1978). See Keith Rosenn, Law and Inflation 295-370 (1982) for a survey of both partial and global adjustment of the income tax in a number of countries. Vito Tanzi, Inflation and the Personal Income Tax: An International Perspective. 1 st ed. (1980) is a comprehensive study from an economic perspective Some more recent articles of relevance to developing countries are Dale Chua, Inflation Adjustment, in Tax Policy Handbook 142 (Parthasarathi Shome ed., 1995) and Milka Casanegra de Jantscher et al., Tax Administration and Inflation, in

-2matter and does not require extensive discussion.2 Inflation adjustment of the income tax base is more complex, being related to the questions of timing that make the income tax so difficult to operate. Section III, which forms the bulk of this chapter, is devoted to the income tax. Global adjustment of the taxation of business income in an environment of high inflation is given particular attention for the following reasons. First, it is the only method that can work reasonably well under conditions of high inflation. Second, while it is well understood in the countries that use this method, it is less well known to tax experts in other countries. Third, once one understands global adjustment, one has a solid framework for analyzing partial adjustment methods (which include all adjustment schemes for taxpayers that do not practice double-entry bookkeeping). These...
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