Tax Notes Talk

Inflation, Tax, and the COVID-19 Economy

March 04, 2022 Tax Notes
Tax Notes Talk
Inflation, Tax, and the COVID-19 Economy
Show Notes Transcript

Martin A. Sullivan, Tax Analysts’ chief economist, provides an overview of the U.S. economy before and during the COVID-19 pandemic, explaining the drastic increase in inflation and what is needed to curb it.

For more, read Sullivan's article in Tax Notes, "Your Quick Guide to the COVID-19 Economy and the Future of Inflation."

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This episode is sponsored by the the American Bar Association Tax Section. For more information, visit

This episode is sponsored by the UC Irvine School of Law’s Graduate Tax Program. For more information, visit

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Host: David D. Stewart
Executive Producers: Jasper B. Smith, Paige Jones
Showrunner and Audio Engineer: Jordan Parrish

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the road to inflation.

Over the last two years, as the U.S. has weathered the COVID-19 pandemic, the economy has seen its share of lows and highs. At the beginning, when everything was shut down, experts were predicting a coming recession, but as things opened up again and relief was passed, the economy seemed to bounce back rather quickly.

So much so, that now the U.S. is facing a different problem: inflation. In fact, the U.S. just posted the highest inflation number in four decades. As the country looks to emerge on the other side of the COVID-19 pandemic, one question keeps popping up: What, if anything, needs to be done to keep inflation in check?

Here to talk more about this is Tax Analysts' Chief Economist and contributing editor, Martin Sullivan. Marty, welcome back to the podcast.

Martin A. Sullivan: Thanks for having me, David.

David D. Stewart: So, before we delve into the economy since the COVID-19 pandemic, let's take a step back. Could you tell us what the economy looked like before COVID?

Martin A. Sullivan: Yeah, it's really important to do that because you really can't understand what's going on with COVID until you understand what was going on before COVID.

So, let's review some amazing facts about the economy before COVID. Before COVID, interest rates were incredibly low. They dropped from 12-14 percent in the mid 1980s to about two percent in the current environment. The economy was growing at a much slower rate than over the historical post-war period.

So, instead of growing at three, three and a half percent, as it did from 1945 to 2010, it was growing at two percent. That was very strange because we had very expansionary fiscal policy, that is we were running huge deficits, and also we had very expansionary monetary policy. The Fed was buying bonds all over the place.

What was going on, and what was very hard to understand, was that we were stepping on the gas with fiscal policy, we were stepping on the gas with monetary policy, but we were still going only 15 miles an hour. This caused a lot of top economists to start thinking about maybe we're entering an era of long term stagnation like Japan had.

If you recall, Japan had two decades of zero growth. The low interest rates are an indication of that, and a very important factor that people forget about are low birth rates, low population growth. Economic growth depends on capital, it depends on productivity, but also depends on people, and when there are less people in the workforce, economic growth slows down.

So, where did that leave us before COVID? Well, we were looking at a high debt-to-GDP ratio, the federal debt was very high, but interest rates were very low. So, the net cost of supporting our debt actually went down. So, what economists were talking about was the need to greatly expand fiscal policy, that is to increase deficits, contrary to what you always hear; you need to reduce the deficit, because the Fed couldn't reduce interest rates any lower.

So, on the eve of COVID, which was March 2020, we were looking at slow growth, we were looking at — if anything — increasing our deficit in order to expand the economy, but then came COVID.

David D. Stewart: All right. Let's turn to the beginning of COVID. We actually had you on the podcast in March of 2020, just at the beginning of the pandemic, right at the time our offices shut down, everyone else started shutting down, and we'll link to that episode in the show notes, but you did say you saw a recession coming. How did your prediction play out?

Martin A. Sullivan: Well, I don't remember the timing on my prediction, but what I would like to emphasize is that the economic events that took place in March of 2020 were absolutely unprecedented. The reduction in jobs was 25 million people were out of work. The reduction in GDP was enormous. We had in 2007-2009, what we called, "The Great Recession." That was one third the size of the job losses and the reduction in GDP that you saw during COVID.

So, it's just absolutely amazing, unprecedented, it should not be swept under the rug, that the economic effects of COVID were just like nothing we'd ever seen before. But then we had the government response, which was also like nothing we've ever seen before.

David D. Stewart: Let's look at that. We saw Congress react in a big way with the CARES Act in April of 2020. Looking back now, what was the impact of that historical package on the economy?

Martin A. Sullivan: It's actually a very interesting story, or as interesting as economics can be. When you go to economic school, they teach you government is usually so slow about responding to recessions, there's a recession in March and maybe by December they'll get around to doing something.

Not this time. Congress and the President acted with remarkable swiftness with the CARES Act and other associated legislation, which greatly increased transfer payments and support to businesses very, very quickly. You have to give the government very, very high marks for the rapidity of their response to the recession.

David D. Stewart: Now looking toward the end of that year, it seemed the economy was bouncing back. Could you tell us about how things looked at that point? And were we seeing inflation then?

Martin A. Sullivan: Right. Let's just remember it was March of 2020 when COVID hit and we all left our offices and so forth. And then during 2020, Congress passed a series of four or five laws pumping lots of money into the economy. The snapback was almost as remarkable as the decline. The 25 million jobs that were lost almost entirely came back. So, employment levels were still low, but most of that deficit in employment snapped back. Same thing with GDP. GDP snapped back at an incredibly high rate.

So, immediately following the monumental amazing shock to the economy, the economy snapped back, not all the way, but most of the way. The stock market, which declined by 30 percent with COVID, by November 4 of 2020 it had entirely bounced back. Before COVID, the Dow was at about 30,000 high, and now, I have to check the paper today, it's about 34,000 now. And housing prices are up.

So, we have housing prices up, we have stock market up, we have the economy almost back to normal. So, there was an amazing comeback right after that — right after the initial shock.

David D. Stewart: Were there signs of inflation at that point?

Martin A. Sullivan: Very interesting. I was making a presentation to a class at Georgetown and I was presenting this data in a PowerPoint slide, and I was surprised to see that there was no significant increase in inflation in 2020. It didn't happen. It didn't really start to kick in until a little later.

Here's the other amazing fact that I stumbled upon. Remember I told you that there was this enormous decline in employment and this enormous decline in GDP, which is the way we normally measure the economy. But you know what didn't decline was personal income.

What is personal income? Personal income is money that people have, disposable income that households have. During the great contraction caused by the pandemic, personal income actually went up. It was just so stunning to me that could possibly be true. And the reason it was true, was that personal income has two components.

One is market income. That is wages, what you get from working and what you might get from dividends and so forth. So, that went over from your small business, that went down. But more than compensating for that, were government transfer payments. Over $650 billion in one quarter, the government pumped into the economy.

And so, actually on average, and certainly not everybody was better off, but if you look at the economy as a whole, the economy was better off because of the incredible injection of this massive amount of money into the economy. This is all happening in 2020, and there's no inflation yet. That's a remarkable turn of events for a nine month period.

David D. Stewart: All right, so then turning to last March. A new president is in office and we have the passage of the American Rescue Plan Act, which we also had you on the podcast to discuss, and we'll link to that one as well.

A year ago you said that additional stimulus was needed, but you said that maybe it was too much for the economy. So, what are your thoughts on that package now looking back a year later?

Martin A. Sullivan: Well, what's pretty clear from the evidence, I mentioned just before that the CARES Act, the 2020 assistance, injected a great amount of stimulus into the economy and increased personal income. So then we get to the beginning of 2021 with the Biden administration, and now the economy's almost recovered, depending on where you look at it, and now we do another massive injection into the economy.

So, what happens is even though the economy is recovering, we have another massive injection and there's so much money in the economy that people aren't able to spend it. People are saving it. And so, there was a massive increase in savings that occurred during this period. That is at the beginning of 2021, one year ago, and this is when inflation started.

The story you can tell is that the first round of relief from the pandemic, the CARES Act, an associated legislation, was sort of necessary to get the economy back on its feet and did not create inflationary pressure, but then the American Rescue Plan gave us another jolt, but it was in the aggregate. Certainly many individuals needed it, but in the aggregate was too much for the economy, and that's what caused inflation.

Where you see it is in the data on savings. You go, "Well, that sounds pretty boring." Let me put it to you this way. Before COVID, the average U.S. citizen — man, woman and child — on average had about $3,000 of cash, let's say in the checking accounts. After these injections from the CARES Act in 2020 and from the American Rescue Plan in 2021, the average American had $11,000 in their checking account.

So, trying to put it in plain human terms, again, this is an average, obviously there's a lot of variation around that average, but if you were walking around saying, "Oh, I need about $3,000 in my account. That's the buffer I like to have." And then all of a sudden you have $11,000, something's going on.

The story that you can tell, which makes sense when you look at all of the data, is that people have more money than they can spend on average, and that's what's driving inflation up. So, in an incredible development, the amount of checkable deposits held by households in the United States in a 12 month period, went from $1 trillion to $3 trillion after being at $1 trillion consistently for a decade. Just an enormous increase.

So, this pent up savings is creating this inflationary pressure, and until those savings are dissipated, we probably will continue to have the inflationary pressure. What could cause that to dissipate is that people need to be able to spend that money.

I use the example, I was cleaning my stove a few months ago and somehow when I turned on the automatic cleaning button basically my stove blew up and now I don't have a stove. I can't bake. I want to order a new stove, but I can't get one. I can't even see one until next April. There's just pent up demand. The stove manufacturers are not going to reduce their prices in that circumstance.

That's a case study, but the data reflects that throughout the economy that people have a lot of spending power, they don't have any place to spend it, and that's driving up prices. Again, I want to stress, obviously low income families may not be in this situation, where they need every dollar they have and they're spending every dollar that they have because they're living hand to mouth, but in general, there is this pent up inflationary demand.

David D. Stewart: Is the microchip shortage that we heard a lot about, is that part of this problem?

Martin A. Sullivan: Yeah. Well, all of the shortages, the microchip, the gasoline, it all contributes.

What we have going on with the pandemic is both the supply side and a demand side a problem. The demand side is we have too much demand. That's what I was talking about, where if the average person went from $3,000 to $11,000 in their bank account, and that is a lot of extra demand in the economy.

And then we have supply chain shortages, like the chips, which actually predated the pandemic, that's also going to contribute to inflation. So, you have both of those things going on at the same time.

The way out of this is either to reduce demand, so let's have a big tax increase. No, I'm just kidding. Obviously that's not going to happen.

The way out of this is for the supply chains to get fixed to allow me to buy my oven, to get those computer chips to the car manufacturers in Detroit. Until folks are able to use up that extraordinary excess amount of saving that's been built up, we'll probably continue to have inflationary pressures.

David D. Stewart: Now, you jokingly mentioned a tax solution to this problem, but are there policy measures that can be implemented that would reduce these inflationary pressures? Maybe not confiscating $8,000 out of everybody's bank account in order to get us back to the original number, but what sort of policy measures can be taken to get us out of this inflationary cycle?

Martin A. Sullivan: Of course, you just turn on your business news station, you will immediately hear about the [Federal Reserve] going to increase interest rates, and that will almost certainly happen throughout the remainder of this year. That will somewhat reduce demand because for folks who are buying on credit, the interest rate will be lower. Folks who are buying houses, the interest rate will be lower. Also, the stock market wealth will go down and people will have less money to spend.

But the other way, and I think the more important way, but politically impossible way, is to actually increase taxes that would reduce consumption, or absorb that savings.

So, as you say, if we confiscated again, massively oversimplifying in the aggregate, but if we confiscated that $8,000 in everybody's bank account, then that would probably eliminate the inflationary pressure that we're now experiencing. But again, that's just not going to happen.

David D. Stewart: Right. I won't claim that you endorsed it. It's fine.

What are you expecting out of the next few years for inflation? I know at the beginning we were told this is transient. This is not going to last very long. Are we looking at a period of 7 percent plus inflation for a few years, or is this something that will come back to normal levels?

Martin A. Sullivan: Let's break it into two parts. The first thing I would say is that over time, that mythical $11,000 I'm talking about will get spent when I can buy my stove, buy my oven, and as the supply chains loosen up and meet people's demand, as restaurants open up again, as people start taking vacations again, that will reduce that inflationary pressure.

I played with some ballpark calculations. In a year or two that will sort of work its way out of the economy. It all depends on how fast the economy can fix the supply side problems. The good news is we don't need any government policies to do that because business wants to figure out how to fix these problems. The free market will fix these problems. As soon as that happens, inflation should settle down.

What we haven't mentioned so far, is this problem from the 1970s, my era, when we had what was called a wage price spiral, which is let's say all the inflationary pressure goes away that I was talking about, but people just start getting so used to inflation that when I'm setting my prices at my local store, I'm just always increasing them by five or 10 percent because I expect that to happen. And when I'm negotiating my wages, I'm always negotiating five or 10 percent more because I just expect that to happen. That was what happened during the 1970s. It's called a "wage-price spiral."

What we don't want is inflation to last so long that people have this sort of built into their expectations. That would be a very bad development. There's no reason necessarily to expect that, but that could happen.

David D. Stewart: Well, Marty, this has been fascinating. Thank you for joining me.

Martin A. Sullivan: Hey, thank you for having me.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?

Paige Jones: Thanks Dave. In Tax Notes Federal, Dan Moalusi examines how the pandemic affected the real estate investment trust industry and various lease restructuring options from a transfer pricing perspective. Mindy Herzfeld examines the new foreign tax credit regulations and explains why they are problematic. In Tax Notes State, Joseph Tantillo and Timothy Noonan review the new guidelines and rule for New York residency audits. Robert Kantowitz criticizes a recent court decision that a Philadelphia residences' taxes paid to Delaware cannot be claimed as a resident credit against taxes owed to the city of Philadelphia. In Tax Notes International, Ege Berber and Aaron Junge analyze the scope and meaning of unilateral measures that countries will have to agree to eliminate under a pillar 1 agreement. Thomas Horst quantifies the federal tax effects of the FDII deduction. In Featured Analysis, Joe Thorndike looks at the argument for more broad based income taxation through comments made by Republican Senator Rick Scott of Florida. And finally, on the opinions page, Nana Ama Sarfo discusses the Biden administration's recent resurrection of decades old Superfund excise taxes, and the need for IRS guidance before the taxes start on July 1.

David D. Stewart: That's it for this week. You can follow me online @TaxStew. That's S-T-E-W. Be sure to follow @TaxNotes for all things tax. You have any comments, questions, or suggestions for a future episode, you can email us at And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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