We've been in the era of 2% inflation so long that many of the distortions it causes have faded from memory. While reading up on iBonds, I remembered one of them: taxes are assessed against total returns, not real returns.
High-inflation example:
- Inflation is 8%
- Your aggregate marginal tax rate is 32%
- You earn 10% interest (2 points above inflation)
So your after-tax yield is 6.8%--somewhat below inflation, so you are not even quite preserving your capital.
Low-inflation example:
- Inflation is 2%
- Same aggregate marginal tax rate of 32%
- You earn 4% (2 points above inflation)
Your after-tax yield 2.76%--somewhat above inflation.
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