Taxation without Legislation - Part III

Over the past two weeks we have explored the allegation that inflation has a larger impact on lower income households than on upper income households.  For those of you that have been with us on this journey, you recall that we have explored the characteristics of households by income quintile and then examined how expenditures change as we move from one quintile to the next higher quintile.  (Remember, a quintile represents 20% of the population and you may think of income quintiles as lower class, lower-middle class, middle class, upper-middle class, and upper class households.)  We have made several observations and, if you need to refresh your memory, you are able to read past “Tips” on our blog: http://mufinancialtip.blogspot.com/ . 

 

This week, we reach our conclusion.  To accomplish this, we will take the average percentage of total expenditures for each quintile to weight the rate of inflation for each category of goods for the 2010 calendar year.  Then, the weighted average rates of inflation for each quintile can be compared.  The US Government’s Bureau of Labor Statistics remains the source: http://www.bls.gov/cex/2009/Standard/quintile.pdf.

 

The percentage of total expenditures by income quintile is presented in last week’s Financial Tip.  Here, however, we need to present the average rate of inflation for 2010 for each category of expenditure.  As one may see in the table below, every category did not increase with inflation the same as every other category.  Inflation rates by category ranged from a minimum of decrease in the average price of Household Operations of 2.50% (-2.50%) to the greatest increase in prices for Tobacco Products and Smoking Supplies of 5.60%.  Two other categories saw their average prices decrease, Apparel and Services and the category of Entertainment.  All others increased in price, while we have recorded 0% increases for the items of Cash Contributions and Personal Insurance and Pensions.  The variation in price increases by category is precisely what makes this exercise interesting, if not fun, for those of us that earn our wages by trying to understand the American consumer.

 

Expenditure Category	2010 Rate of Inflation
Food
Food at home	1.70%
Food away from home	1.30%
Alcoholic beverages	1.00%
Housing
Shelter	0.40%
Utilities, fuels, and public services	1.80%
Household operations	-2.50%
Apparel and services	-1.10%
Transportation	5.30%
Healthcare	3.00%
Entertainment	-0.80%
Personal care products and services	0.70%
Reading	3.50%
Education	1.30%
Tobacco products and smoking supplies	5.60%
Miscellaneous	2.20%
Cash Contributions	0.00%
Personal Insurance and Pensions	0.00%

Now, here is the punch line.  First, when rates of inflation are weighted by each quintile’s proportion of total expenditure, we see that the average rate of inflation for all consumer units was 1.32%.  Focusing on the rate which includes cash contributions and pensions we find that the average rate of inflation is less than the rate of inflation for each of the first four quintiles.  Only those in the top quintile have an average rate of inflation (1.15%) that is less than the overall average.  We find the greatest rate of inflation, based on the calculated budget shares and reported category rates of inflation to exist in the second lowest quintile (1.50%).  This second quintile is followed by the third quintile (1.45%), the lowest quintile (1.40%), the fourth highest quintile (1.39%), and then the highest quintile (1.15%).  However, the lowest quintile experienced a rate of inflation that was 21.7% greater ((1.4030/1.1526)-1) than the highest income quintile.  

 

	All consumer units	Lowest 20 percent	Second 20 percent	Third 20 percent	Fourth 20 percent	Highest 20 percent
Rate of Inflation	1.3226%	1.4030%	1.4977%	1.4470%	1.3880%	1.1526%

 

What do we conclude for 2010?  Inflation had a lesser effect on the top quintile in 2010, than others in our population.  As such, it does “tax” those in the lower quintiles to a greater extent than our highest income citizens.   The differences exist due to the fact that we used average percentage expenditures by category to multiply times average rates of inflation per category, to calculate a weighted average. 

 

The best take home message is to be aware of differences that exist due to how you spend your money.  In fact, not spending your money is a great way to avoid paying any price (except for unanticipated inflation) and to save to reach your definition of financial success.