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inflation is also a form of taxation
February, 14th 2009

How to finance rural development? Some economists have suggested that the simplest way to finance development in developing countries is to print money or borrow from the banking system; in short, by deficit financing or controlled inflation, writes Katar Singh in Rural Development: Principles, policies and management,  third edition (www.sagepublications.com).

But, inflation is also a form of taxation, the author argues. It is really a tax on cash balances, since those individuals and organisations in the economy who hold cash balances see their purchasing power eroded by inflation, he adds.

There is, thus, a transfer of wealth from those who hold money in the form of cash balances to those who obtain the resources (in this case the government) through money creation. The government borrows heavily to finance spending, including that for rural development.

Singh rues that inflation tax which can be a politically easier way of taxing people than direct taxes affects hundreds of millions of people, though very few realise the same. Most people value their investment and income without adjusting it for inflation. This is what is called money illusion in economics.He reasons that inflationary (deficit) financing of the regular budget in the hope that a rising price level will in itself provide incentive for private investment in development projects is unlikely to be successful.

However, if the government undertakes a large-scale development programme, recognising that the level of deficit financing is in itself inflationary and mops up increases in income through tax policy, monetary policy and direct controls, then mild inflation can have a positive impact on economic development.

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