Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio

Chapter 5. Linking Up

Monetary policy, as wielded by the Federal Reserve (the Fed), affects the economy and stock market in distinct ways. It certainly impacts investor horizons and, once a monetary move is made, it can also reduce uncertainty. But another effect has to do with the interaction between inflation and the tax code. Numerous channels exist through which this interaction occurs. Inflation pushes people into higher tax brackets, creates illusory capital gains, and (given historical depreciation) generates false profits at the corporate level. All these effects suggest inflation alters the economy’s marginal tax rate, even if legislated tax rates remain unchanged.

Interaction Between Inflation and the Tax Code

In what follows, I focus ...