(Nominal Value) Taxation is Theft

This article is not meant to give financial advice. I am not a financial advisor. Nor is this article meant to provide tax advice. I am not an accountant either.

Background and Terminology

In œconomics, there is a distinction between what is termed nominal value and real value. The nominal in nominal value gives us a hint as to its meaning. It refers to the number value that we might see at the store, such as $4.00 for a gallon of gas. However, the real value refers to what goods or services we can purchase and is thus related to the concept of purchasing power. While we may be able to buy a gallon of gas for $4.00 today, if we were able to purchase a gallon of gas for only $2.00 last year, then the real value of our dollar is now half of what it was a year ago (at least in relation to gas).

Thus, real value can be thought of as taking inflation into account. For example, if the price of a gallon of gas is $4.00 today and was $2.00 last year, the real value of gas (with all else being equal) has not changed. Yet, the nominal value has doubled (I say all else being equal because the real value of any commodity can in fact change, in addition to nominal value changes, but we can ignore this for simplicity’s sake to illustrate the main point).

Ideally, the real and nominal values stay consistent with each other, as the available money supply, which can be seen as representing a claim on the production of a given œconomy, moves in proportion to the actual production of the œconomy.

The Basics of Capital Gains

With this bit of terminology out of the way, Let’s look at the concept of capital gains tax. I have to pay a capital gains tax when I purchase some asset, such as a stock or some cryptocurrency, at a particular dollar value. Then the dollar value of the asset increases, and I later sell (or otherwise transact with) the asset at this higher dollar value. I have to pay a capital gains tax on the difference.

For example, say last year I purchased one coin of a cryptocurrency called the “purchasing power coin” or PPC for short for the value of $1000 (I am not aware of any real cryptocurrency going by this name, but if there ever is in the future, this is merely an example and not intended to refer to such a coin). Then, over the last year, say the value of my PPC went up to $2000, and I sell my PPC today for $2000. Now I will have to pay capital gains tax on the $1000 difference (the tax rate will vary according to several factors, one of which is the total amount of the gain).

What Causes the Change in Nominal Value?

In the previous example, my PPC was worth $2000 at the end of the year and only $1000 at the beginning. What factors play a role in this increase (in nominal value)? While there are many ways to look at it, the various factors can be grouped as factors related to change in real value and factors not related to change in real value.

What might cause the real value to increase? If PPCs are more desirable for some reason, e.g., a new store opens that only accepts PPC as payment, then people will be willing to give more goods and services per PPC than before. While many other potential factors affect real value, this one should be sufficient to illustrate the basic concept.

One main factor affecting the nominal value is, in fact, changes in the real value. With all else being equal, if the real value of my PPC has doubled, then the nominal value should also approximately double. Other factors affect nominal value, however. The largest of these factors is probably inflation (or deflation). Inflation is generally seen as the increase in the (nominal) price level over time. A currency can be inflated when for instance, more of it is produced, without a corresponding increase in production that such a currency represents a claim against.

Example 1

Let’s look at an example. If one can earn one PPC for 50 hours of work, and later the PPC is discontinued in favor of a new cryptocurrency, PPC2, which is identical to the PPC except there are twice as many of them. Each owner of a PPC is automatically given two PPC2 for each PPC they own. After the switch (assuming the real value of labor is relatively stable), one will not pay only one PPC2 for 50 hours of work but two PPC for 50 hours of work. The nominal value of 50 hours of work will be higher (2 rather than 1), but the real value is the same.

Example 2

What if, instead of creating a new currency, PPC2, we continue using the same currency, PPC, and everyone who has PPC automatically has their PPC amount doubled? The case is the same. The nominal value of 50 hours of work has doubled (2 versus 1 PPC), but the real value of the 50 hours of work is the same.

Example 3

What if instead of automatically doubling the amount of PPC all PPC holders have, the total supply of PPC is doubled, but all of the new PPC is given to one particular person (called PPCProducer, for instance)? Surely we can’t expect to still make one PPC for 50 hours of work, as now the total pool of PPC is much larger, while the amount of goods, services, etc., (broadly speaking, production) is otherwise the same. So, in theory, in this scenario, one should receive two PPC for 50 hours of work. Yet, in practice, what will instead happen is some intermediate value will be settled upon, such as 1.5 PPC for 50 hours of work. In this case, the nominal value of 50 hours of work has increased (1.5 versus 1 PPC), but the real value has decreased. Thus, the laborers have effectively received a pay cut.

Why doesn’t the rate for 50 hours of work increase to two PPC in this case? There may be twice as many PPC in existence, but those hiring laborers still have the same supply of PPC. This is because all of the new PPC went to one person. Thus, even though the wages should increase in proportion to this inflation of PPC, they do not raise wages entirely in proportion to the inflation to not exhaust their supply of PPC twice as fast. Thus we can see that, in fact, not only have the real value of wages gone down, but the real value of the PPC supply held by both the labor-buyers and laborers has gone down as well.

With all of this value going down, who has benefitted in this scenario? One person, PPCProducer, has seen an increase in both real and nominal value held. If PPCProducer had no PPC before, PPCProducer now owns half of the total PPC. That is a significant increase! Thus PPCProducer formerly held no real value but afterward held half of the real value of the entire PPC supply. At the opposite extreme, if PPCProducer had all of the PPC before, then there will be no increase in real value as PPCProducer will still hold all of the PPC, the nominal value will just be doubled. So for all of the amounts of PPC held prior between no PPC and all of the PPC, the increase in real value is a positive value between the increase if none were held before and 0 (the increase if all of the PPC was held before).

Inflation as a Tax

Thus, the production of more PPC can be seen as a sort of tax on all wealth held in PPC, and the tax revenue goes to whoever is given the newly produced PPC. Generally speaking, the real value of the holdings of each person changes in proportion to the percentage of new coins received compared to the percentage of the total supply of coins they held prior to new coins being created. Thus, if everyone’s holdings are automatically doubled, as in example 2 above, the real value that everyone holds stays the same as everyone has received the new coins precisely in proportion to their previous holdings. This would also be the case whether they receive 1 new PPC per old one, half a PPC per old one, or even 37 new PPC per old one. In each scenario, the real value held will stay the same as each receives precisely in proportion to their prior holdings. The difference in these cases is in how much the nominal value changes.

However, if the new coins are not given out in proportion to previous holdings, such as in example 3 in the most extreme way, then those who receive a smaller percentage of the new coins than the percentage of PPC held compared to the old total will have a reduction in the real value they hold to a certain extent. On the other hand, those who receive a higher percentage of the new coins than their percentage of the previously held PPC total will have their real value increased. Thus, whenever there is a discrepancy in this proportion, there will be winners and losers, the taxed, and the beneficiaries of the tax.

This is all, of course, assuming that the supply is changed without corresponding change in available goods, services, etc. (i.e., production).

Inflationary Currency and Capital Gains Tax

With all these concepts in mind, let us consider how to best look at capital gains tax. Taking from our earlier example, let’s say that last year I purchased 1 PPC at the price of $1000. Then, over the previous year, the government prints many new dollars to pay for various things, which results in some increase in production, but of a lesser extent than the printed money. Today I sell my 1 PPC for a price of $2000. To make things simple, let us assume that not much has changed in the real value of PPC (i.e., I can purchase about the same amount with 1 PPC today as I could last year (i.e., my claim to the relative production of the PPC market is quite stable). This is not likely to be entirely true in the real world, but for the sake of the argument, this is not important as any change in real value will just cause an additional change in nominal value rather than take the place of changes in nominal value in the absence of real value change). Thus, when I make my sale, I am accountable to pay tax on $1000 worth of capital gains. But what type of value is this $1000?

Given the assumption that the real value of PPC has held relatively constant, we see the change in nominal value of a PPC from $1000 to $2000 due to the inflation of the dollar by printing more dollars over the year, beyond increases in production. Thus the capital gains tax on my $1000 is on purely nominal, not real value. On the other hand, if the PPC had also undergone some change in real value, then the amount subject to the capital gains tax would be partially due to some real value change and partially due to nominal value change alone.

Yet why should we pay tax on nominal value change alone? I cannot buy any more with my PPC than I could a year ago. I have not gained any real income and real value from my asset. I have already paid income tax on the initial $1000 (capital generally is just old-labor); thus, I have also paid tax on the real value held by the $1000 at the time of purchase. This is the same real value that I now hold before paying the tax on the nominal value. After paying the tax, I have actually seen a reduction in real value. Capital gains turns out to be quite the misnomer.

Why is Nominal Value used for Taxation?

With the above problem with nominal value taxation outlined, why do we use it? Well, a straightforward answer is just that it is easier. It is not always easy to determine the real value of holdings, especially over time, and with respect to different goods and services. Using the nominal value, we have an easy way to account for what tax must be paid without recourse to other calculations. While this simple answer is true, it is perhaps not the entire story.

As I mentioned earlier, when a currency is inflated, not all prices are inflated proportionally, such as wages, although this applies more broadly to all sorts of goods and services. This is the case even though, in theory, the prices should all adjust accordingly as they hold the same real value as before. Over time, prices should trend toward this, but they will never (or rarely) reach the expected price outside of theory. Yet, despite not always having a one-to-one correspondence, the presence of inflation will always cause some fall in the real value of money, even if prices don’t immediately react accordingly. In The Theory of Money and Credit Austrian school œconomist Ludwig von Mises defines inflation thus, stating that “in theoretical investigation there is only one meaning that can rationally be attached to the expression Inflation: an increase in the quantity of money … that is not offset by a corresponding increase in the need for money … so that a fall in the objective exchange-value of money must occur” (p. 272).

With this definition, the concept of inflation as a form of tax that I proposed earlier is more readily seen. Yet whom is inflation taxing? When the government prints more currency (or in reality, what is even worse, private banks create more currency which is lent to the government at interest), inflating the dollar, it is acting as PPCProducer in example 3 above, taxing everyone who holds any dollars, reducing their real value held, and keeping the extracted value for itself in the form of the newly printed currency (or giving it to those specific individuals it deems deserve it). Thus inflation is a sort of invisible tax. It is not a tax that you will see being withheld from your wages, but it is one which you will pay nonetheless if you hold any value in dollars.

That is just the thing though, you only pay the tax if you hold your assets in dollars. If you purchase some other asset, say a cryptocurrency like PPC in the above examples, you are no longer affected by the invisible inflation tax. That is until you have to pay capital gains tax. By paying capital gains tax on nominal rather than real value, the invisible inflation tax is extended even to those not holding their assets in dollars. This is another, and perhaps more important, reason that capital gains tax is calculated using nominal rather than real value. However, it is pretty deceptive as it is taxing (at least in part) when there are no real gains to be had. This tax, however, is not invisible like the inflation tax but acts as a misnamed portion of an otherwise visible tax on (real) capital gains.

Conclusion

Why is this so convoluted and misleading? Why not be upfront about the inflation tax and the nominal capital gains (in place of invisible inflation) taxes? This is a complex topic, which Saifedean Ammous covers in his excellent book The Bitcoin Standard. In short, invisibly taxing through inflation allows governments to extract more value from their citizenry to fuel various projects (such as war typically) before the citizenry revolts, as they cannot see the taxes as readily.

Thus, nominal value taxation is theft, and for that matter, so is invisible taxation through inflation, of which nominal value taxation on capital gains is merely an extension.