Deflactar: The tax strategy that impacts your investments during times of inflation

The Economic Context of 2022: Inflation and Fiscal Restraint

During 2022, governments and central banks in Europe and the United States implemented unprecedented monetary policies. The uncontrolled rise in prices for goods and services led to a massive loss of purchasing power among consumers, regardless of their income level. In response, restrictive fiscal measures were adopted: raising interest rates, increasing taxes, and reducing public spending. Specifically, in Spain, inflation reached 6.8% in November 2022.

Faced with this challenging scenario, an important debate emerged about a fiscal measure called deflating. What exactly is deflating, and how could it affect your investment strategy?

Understanding What Deflating Means in Economics

Deflating is a fundamental concept in economic analysis that allows for comparing the real performance of economic variables over time, removing the noise caused by inflation or deflation.

Imagine you want to assess whether your business truly grew or if it only appears to have grown due to rising prices. A deflator is precisely that figure which expresses price changes over specific periods for particular products, baskets of products, or indicators like Gross Domestic Product (GDP).

Practical example: Country X produces goods and services worth 10 million euros in year 1. In year 2, nominal GDP rises to 12 million. Without considering inflation, we would say the economy grew by 20%. However, if prices increased by 10% during that period, the real figure is different. When normalizing considering the inflation impact, we find that the economy actually grew only 10%. The nominal GDP would be 12 million, while the adjusted real GDP would be 11 million.

This distinction is crucial for investors and analysts because it helps identify genuine growth versus apparent growth.

Deflating the Personal Income Tax (IRPF): A Measure to Protect Purchasing Power

In the Spanish debate, “deflating” takes on a specific meaning related to the Personal Income Tax (IRPF). It is a fiscal measure aimed at reducing the taxpayer’s burden, mainly through:

• Adjusting progressive tax brackets according to inflation
• Increasing tax deductions
• Applying tax credits that reduce the total tax obligation

Why is this important? The IRPF is progressive, meaning that higher income results in a higher percentage of taxes paid. Without deflating, when a worker receives a nominal salary increase (due to inflation), they automatically move into a higher tax bracket, paying more taxes without having truly improved their economic situation. This further reduces their purchasing power.

Countries like the United States, France, Germany, and Nordic nations already deflate the IRPF annually (or every two years in the case of Germany). In Spain, this practice has not been implemented nationwide since 2008, although several autonomous communities have announced plans to do so.

Dual Impact of This Fiscal Measure

Arguments in favor: Proponents argue that deflating protects the average citizen from losing purchasing power in inflationary contexts, allowing families to maintain their buying capacity.

Arguments against: Critics point out that it mainly benefits high incomes (due to the progressive nature of the tax), creating inequality. Additionally, they warn that recovering purchasing power could increase aggregate demand, potentially driving prices even higher. There is also concern about reducing public revenue available to fund essential services like education and healthcare.

Investment Strategies in Inflationary Contexts

When deflating the IRPF and increasing investors’ disposable income, demand for financial assets could rise. Here are strategic options based on risk profiles:

Safe-haven assets: Commodities

Gold has historically maintained its value during periods of economic uncertainty. When inflation is high and interest rates rise, gold does not generate interest like government bonds but offers long-term appreciation potential. Historically, gold has always increased in value, although in the short and medium term, it can be quite volatile.

Stock Market: Strategic Selection

High inflation and elevated interest rates are generally adverse for the stock market, reducing investors’ purchasing power and increasing corporate financing costs. This results in lower profits and falling stock prices, as occurred in 2022.

However, not all sectors respond the same. Energy companies posted record profits in 2022, while technology stocks plummeted. During recessions, the market can present opportunities for investors with liquidity and a long-term horizon: prices fall significantly, but historically, the market recovers and grows after major declines.

Diversification into low-risk assets

Treasury securities and government bonds are designed to provide returns adjusted for inflation, offering relative stability in mixed portfolios.

Currency Market (Forex)

Exchange rates are affected by changes in inflation and interest rates. High inflation can depreciate the national currency, making foreign currencies attractive, which could appreciate. However, forex is highly volatile and carries considerable risk, especially with leverage, where small initial investments can lead to large losses.

Final Conclusions

Deflating the IRPF could have several positive impacts on the investment environment:

• Increased investment capacity: Taxpayers with higher available income might increase investments, especially in income-generating assets like stocks or real estate.
• Sectoral reorientation: If the measure includes incentives for specific sectors (green energy, technology), investors are likely to concentrate funds there.

However, it is important to be realistic: the actual economic benefits for an average person amount to only a few hundred euros annually. Therefore, overestimating the transformative impact of this measure on national investment levels would be unrealistic.

Ultimately, understanding what deflating is and how it works is essential for navigating investment strategies during periods of inflation and economic volatility. The key is to diversify prudently and maintain a long-term perspective.