Tax Freedom Day (TFD) has come and gone in South Africa. TFD is the percentage of GDP the general government uses as revenue for its purposes, expressed as a percentage of the year in days gone by.
Unfortunately, it got a bit worse. It was May 15 this year – four days later than last year. The main driver of long-term government revenue is long-term government spending. So, some economists argue that inflation and the deficit are stealth taxes and that I should add them to tax revenue when calculating TFD.
While I agree with the premise, I have avoided doing so for the last 30 years, for several reasons. I will not discuss those reasons in this article. Here I want to explore the connections between spending, revenue, inflation, borrowing and budget deficits, and their implications. The average person’s experience of inflation is a perception of an ever-increasing cost of living, an erosion of (or barrier to) savings, and an expectation of having to have yet another fight for higher wages.
That is bad enough, but it is even worse. Mostly people do not know about the causes of inflation and the hidden tax effects.
Milton Friedman has informed what I have to say about these connections. The Nobel committee awarded him the economics prize for his contributions to consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy.
To summarize his findings: People base their spending on their long-term expected incomes rather than any transitory income. Monetary contraction, rather than private market failure, caused the Great Depression. He pioneered an understanding of monetarism and correctly predicted the 1970s stagflation. I focus here on just two of his many insights – that “inflation is always and everywhere a monetary phenomenon” and “inflation is ultimately caused by government spending”.
By ‘monetary phenomenon’ Friedman means that money is worth less per unit when it increases relative to the stock of goods and services. You now need more money to pay for the same stuff. A money unit increase is always the result of printing cash or providing credit beyond what you need to purchase the current supply of goods and services at their original prices.
Friedman goes on to say that whenever government wants to spend it must finance this from the revenues it collects, and if that falls short of its requirements it has to borrow or print money. The obvious consequence of borrowing or printing money for excess spending is that there is now excess money chasing the same goods and services. In other words, inflation.
Inflationary implications
Government spending within the limits of tax revenue also has inflationary implications. When government steps into markets where private enterprise is active the purpose is to correct what it deems a ‘market failure’. That is, government provides goods or services to those who were not buying it from private enterprise.
Usually those who do not buy are choosing to spend on a more important need instead. Government however thinks it knows what people should prioritise better than they do. It does not. Government cannot possibly know the circumstances and choices facing every individual in the country. Supplying whatever people do not prioritise in essence forces a misallocation of resources. This distorts the signalling effect of prices, fooling the market into supplying too many of some things (waste) and too few of others (shortages). The distorted trade-offs between choices in a context of limited resources end up providing a smaller overall stock of value i.e., a smaller economy.
The government part of the market will be relatively inefficient. It produces less per unit of input because of corruption, less-able employees and bureaucratic friction. That means fewer goods and services chasing the same amount of money – inflation.
Central banks combat inflation by raising interest rates, the cost of borrowing money. That reduces investment and consumption and in turn reduce prices. Prices stop rising, or fall, because suppliers need to make it worthwhile for customers to buy. Now profits shrink and government ends up with less revenue. Taxes come from profits after all. If the state does not reduce spending, that sets up conditions for future inflationary pressures.
Ideally inflation should be low and stable. Deflation is bad because it tends to cause recessions. High inflation is bad because it creates a false signal of need and therefore malinvestment. Malinvestment results in business collapses in the future. High inflation is also bad in that it erodes savings and security and increases the cost of living.
Monetary wisdom suggests inflation should be zero, but because the effects of deflation are worse than inflation it pays to err a little bit above zero.
Encouraging
South Africa’s core inflation rate is currently 3.3% and its GDP deflator (a more comprehensive measure of inflation) 2.8%. In 2025 these were 3-4.8% and 5.7% respectively. That drop is encouraging and is in line with Friedman’s theory that government spending drives inflation.
The SA department of finance has recently put the brakes on spending. Whether that trend survives the paying down of government debt remains to be seen. I hope so, but am not holding my breath. As with most of the developing world, our government doubles down on government activity and enterprise and opposes people doing their own thing in liberty.
Inflation is one more reason for the people to combat large government for its own sake.
[Image: Gerd Altmann from Pixabay]
The views of the writer are not necessarily the views of the Daily Friend or the IRR.
If you like what you have just read, support the Daily Friend