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Throughout his career, famed economist Milton Friedman described inflation as a “hidden tax.” When prices rise consistently, he warned, they cut into consumers’ purchasing power, forcing them to earn more money (and pay more in taxes) to maintain the same lifestyle. On top of that, nominal wage and revenue increases during periods of high inflation can end up pushing an unlucky group of consumers and businesses into higher tax brackets even as their purchasing power falls—an effect called “bracket creep.”

“Inflation is a form of taxation without representation. It is the kind of tax that can be imposed without being legislated by the authorities and without having to employ additional tax collectors,” Friedman famously wrote in a 1974 article that called for the indexing of tax brackets in order to prevent “bracket creep.”

This so-called income-tax feature of inflation has made it incredibly unpopular among the public. As Tom Barkin, president of the Federal Reserve Bank of Richmond, explained in a recent interview with CNN:

“The one thing that I hear loud and clear from everybody is that they hate inflation. They find inflation to be unfair. You get a raise, and then you have to spend that raise at the gas station,” he said. “It’s frankly exhausting.”

But now, new research has added a wrinkle to the popular view of inflation as nothing but a downer. In a new working paper whose title asks, “Is There Really an Inflation Tax?” New York University economist Edward Nathan Wolff, an expert on inequality with nearly 40 years of research to his name, breaks down the effects of inflation on Americans’ overall wealth between 1983 and 2019.

His answer? The “inflation tax” does exist, but not for everybody. The middle class and the top 1% of Americans actually benefited from periods of high inflation in recent decades. “With regard to the issue of whether there is really a net inflation tax, the answer is that it is true for some groups only,” Wolff wrote.

A ‘tax’ that hits unequally

In his paper, which was published this month by the National Bureau of Economic Research, the official arbiter of business cycles, Wolff pored over data from the consumer price index and Federal Reserve’s Survey of Consumer Finances (SCF) to measure changes in consumers’ incomes and overall wealth during periods of sustained inflation.

The economist, who serves on the editorial board of the Journal of Economic Inequality and the Review of Income and Wealth, found that although there is definitely an “inflation tax” on consumers’ incomes—measured as the difference between nominal and real income growth—there’s another, more positive side to inflation as well. (Wolff’s books on inequality include 2015’s Inheriting Wealth in America: Future Boom or Bust? and 2017’s A Century of Wealth in America.)

Inflation can cause asset prices, particularly in real estate, to rise substantially, while simultaneously lowering the real debt burdens of some consumers. This means that a lucky group of households that have a large amount of assets or debt relative to their incomes—say, recent homebuyers who are “house poor” or the ultrarich—have historically seen a sizable gain in household wealth thanks to inflation, Wolff explained.

“In terms of household well-being, inflation is a net boon to the middle class. The top 1% of the wealth distribution also gains handsomely from inflation. On the other hand, poor households (the bottom two quintiles in terms of wealth) get clobbered by inflation,” he wrote.

Comparing the difference between inflation’s erosion of incomes and its boost to wealth, Wolff calculated the “net inflation gain” or NIG for each income bracket in the U.S.

The top 1% of Americans saw a “robust” NIG of $63,500, or 6.9% of their mean annual income between 1983 and 2019. However, for those who were merely very wealthy, but below the 1%, it was a different story.

Those in the 95th to 99th percentile of wealth have a much lower wealth-to-income ratio, which caused their NIG to come in at -$56,200, or 18% of their mean income. NIG was also negative for Americans in the 80th to 95th percentile of wealth.

The equation flips for the upper middle class, however. Americans in the 60th to 80th wealth percentile—today, that means a household net worth of roughly $200,000 to $550,000—tend to have a high portion of their wealth in real estate. As a result, for this group, inflation led to a NIG of $12,700, or 16% of their mean yearly income between 1983 and 2019. Essentially, inflation eroded these consumers’ mortgage payments and inflated their assets more than enough to make up for the losses their income took from having to pay more for other goods and services.

The boost was even bigger for squarely middle-class households, or those in the 40th to 60th wealth percentile. This group saw an NIG of nearly $40,000, or two-thirds of their annual income. “Indeed, inflation has been a boon to the middle class in terms of its balance sheet,” Wolff wrote of the findings.

For the bottom two quintiles of the wealth distribution, however, inflation remains a nightmare. Wolff found that this group’s NIG was -$19,300, or almost half of their mean income. “It is clear that poor households were particularly hard hit by inflation,” he wrote.

Wolff said his findings pose an urgent question: “Why is the public, particularly the middle class, so opposed to inflation?”

His answer was that consumers tend to feel the psychological effects caused by inflation eroding their incomes, but they are often “not aware” of the commonly positive effects that it can have on their assets and debt. It’s easy to see rising prices at the grocery store or while filling up at the gas station, but for many consumers, the positive wealth effect that comes from inflation lowering the lifetime real cost of a mortgage is less obvious.

However, the Great Recession, the pandemic, and the dotcom bubble all helped push more Americans out of the middle class, at least in terms of income, over the past decades. Between 1971 and 2021, the number of “middle income” Americans fell from 61% to 50%, according to a Pew Research Center analysis. Part of the reason for this hollowing out of the middle class was a seven-percentage-point increase in the “upper income” category, but the amount of lower income Americans also grew by five percentage points—and many have blamed inflation for that outcome. A point that Wolff doesn’t touch on is that inflation is massively unpopular because the hidden tax is affecting more Americans who are missing out on entry into the middle class.

Should the Fed be aiming at a higher inflation target?

Overall, Wolff’s findings suggest that lower rates of inflation would protect poorer families, but also hurt the middle class, thereby (ironically) raising overall wealth inequality. This has implications for federal policy, and suggests, rather than the Federal Reserve’s longtime target of 2% inflation, it could make sense to have a slightly higher overall inflation target. Of course, that higher rate comes with its own issues for the poorest Americans.

To combat the negative effect of inflation on the poor, Wolff proposed an interesting solution: an inflation tax credit. He argued that the IRS should calculate the rate of inflation in the preceding year and then use that figure to “modify the tax code” and offer incentives to those most affected by rising prices.

“Varying this tax credit across the income distribution could reduce the burden of inflation for poor families while still allowing middle-income families to capture its benefits,” he wrote.