How Personal Tax Deflation Shapes Your Investment Decisions in 2023

The economic landscape of recent months has radically transformed the way investors should rethink their portfolios. While central banks continue to implement restrictive policies through interest rate hikes, a fiscal measure has emerged that could change the game: the deflation of personal income tax. What does this really mean for your investment strategy?

The Deflator Explained: Your Economic Compass

When comparing economic performance over time, we face a fundamental problem: inflation distorts our perceptions. A country reporting 20% GDP growth might actually only experience 10% growth once we remove the inflationary effect of prices.

This is where the deflator comes into play. It is an indicator that adjusts economic variables by eliminating price fluctuations, allowing you to see only real changes in volume and production. For example, if a nation produces 10 million euros worth of goods in year one, and 12 million in the next year, we might assume a 20% growth. However, if prices increased by 10% during that period, the economy actually grew only 10% in real terms (Real GDP: 11 million).

This concept applies to companies, wages, investments, and virtually any economic metric that requires historical comparison. Economists use deflators to analyze the behavior of indicators such as the CPI (Consumer Price Index), corporate sales, or worker compensation over time.

Deflating the Personal Income Tax: A Fiscal Measure Under Debate

In the context of high inflation recorded at the end of 2022 (6.8% in Spain), politicians and governments have intensely debated deflating personal income tax as a tool to preserve citizens’ purchasing power.

What does this fiscal deflation really mean?

It involves adjusting the progressive tax brackets of the IRPF according to inflation, preventing taxpayers from losing purchasing power when they receive nominal salary increases. Without this adjustment, a person earning more could pay a higher percentage in taxes simply because they crossed into a higher bracket, even if their real purchasing power hasn’t improved.

The Spanish IRPF is a direct and progressive tax that levies income of residents during a calendar year. Its structure includes regional and national brackets. This deflation measure is routinely implemented in the United States, France, Nordic countries, and even in Germany (every two years), but in Spain, it has not been applied nationwide since 2008, although some autonomous communities have started to implement it.

The Political Dilemma: Benefits vs. Side Effects

Arguments in favor: Supporters argue it protects families from inflation erosion, maintaining their purchasing power without relying on real salary increases. This is especially important during periods of economic stagnation.

Fundamental criticisms: Opponents warn that it disproportionately benefits high incomes due to the progressive nature of IRPF, increasing inequality. Additionally, by increasing consumers’ disposable income, it could stimulate aggregate demand, further pressuring prices rather than controlling them. Moreover, the reduction in tax revenues could compromise funding for essential public services.

It is relevant to mention that the actual economic impact for the average person is around a few hundred euros annually, so attributing significant changes in national investment levels solely to this measure is speculative.

Investment Strategies During Inflation and Rising Rates

When facing an environment of high inflation combined with rising interest rates, your portfolio experiences opposing pressures. However, proven approaches exist:

Commodities: The Traditional Safe Haven

Gold has historically proven to be a store of value during inflationary turbulence and when interest rates rise. Unlike government bonds (taxed in the IRPF), gold does not generate periodic coupons but maintains purchasing power over the long term. Its detachment from national currencies makes it attractive when the local currency loses value. However, in the short to medium term, it can experience significant volatility.

Equities: Selective Growth

Inflation and high rates are generally adverse for the global stock market. They erode investor profitability and make corporate borrowing more expensive to finance operations. During 2022, we saw this effect: the tech sector plummeted while energy companies hit record profits.

But here’s the nuance: within this unfavorable landscape, certain companies thrive. Those that trade in goods and services with inelastic demand (necessities) or that benefit from uncertainty show resilience. Paradoxically, recessions can present opportunities for long-term investors with liquidity, buying depressed stocks that historically recover and grow significantly.

Currencies (Forex): High Risk, High Volatility

The forex market responds sensitively to inflationary changes and rate fluctuations. Elevated inflation typically depreciates the domestic currency, creating opportunities to appreciate foreign currencies. However, forex is highly volatile, especially with leverage, where small movements generate disproportionate gains or losses. Only recommended for experienced traders.

Diversification: Your Protective Shield

Regardless of the situation, combining defensive assets (Treasury bonds, government-backed fixed income securities) with growth assets (selective stocks, commodities) reduces systematic risks. Inflation affects different assets unequally, so a balanced portfolio navigates turbulence better.

Impact of IRPF Deflation on Your Investment Portfolio

How much would the landscape change if IRPF were deflated?

Increased disposable income among investors could boost overall demand for financial assets, especially income-generating vehicles like stocks and real estate, whose after-tax returns would improve.

Specific sectors might attract more capital if the fiscal structure included incentives for certain segments (renewable energies, green technology), redirecting capital flows toward those areas.

However, these effects would be gradual and marginal. The average increase in disposable income from deflation (hundreds of euros) probably would not massively transform strategic investment decisions.

Final Reflection: Beyond the Fiscal Measure

The deflation of IRPF is a legitimate political tool to preserve purchasing power in inflationary contexts. Its real economic benefits, though modest at the individual level, help families maintain financial stability.

For investors, it is crucial to understand that in scenarios of persistent inflation and restrictive policies, your strategy should evolve toward a combination of assets with an embedded deflator: inflation-linked bonds, companies with pricing power, commodities, and especially, smart diversification.

Remember: no investment is risk-free. Volatility is an inherent characteristic of financial markets, especially during macroeconomic transitions like the current one.