I recently reviewed how tax adjustments actually work in inflationary economies, and I was surprised at how little is discussed about this in investment communities. Most people don’t understand what “deflated” means in the context of their taxes, so I’m going to unravel this.

It all started in 2022 when inflation skyrocketed in Europe and the United States in a way we hadn’t seen in decades. Central banks raised interest rates dramatically, and suddenly governments began talking about a measure that sounds technical but directly impacts your wallet: deflating the IRPF.

Here’s the basics. Deflating is an economic concept that adjusts values to eliminate the noise of inflation. When you deflate something, you’re saying: “Hey, let’s remove the effect of rising prices to see what really happened.” For example, if your company’s revenue grew from 10 to 12 million but prices increased by 10%, you only grew 10% in real volume, not 20%. That’s deflating.

In Spain, the idea was to apply this to income tax. If your salary increases because of inflation, you shouldn’t pay more taxes just for that. But here’s the issue: while in the US, France, and Nordic countries they make this adjustment annually, in Spain they hadn’t done so since 2008. Only in 2022 did some autonomous communities start considering it.

The logic is simple. Inflation destroys purchasing power. If you earn more nominally but prices rise the same or more, you haven’t gained anything. And if your tax burden increases because you move into a higher bracket, it gets worse. Deflating the IRPF tries to prevent that.

Now, opponents say it’s a measure that benefits higher earners more (because IRPF is progressive), and that if people maintain their purchasing power, they keep spending, demand doesn’t fall, and prices don’t drop. That’s a valid argument.

But here’s what’s interesting for us investors. If IRPF is deflated, people have more disposable income. That potentially boosts demand for investments. In 2022, we saw how inflation and high interest rates crushed tech stocks but greatly benefited energy companies. The market doesn’t move the same everywhere.

If you’re an investor with liquidity and a long-term horizon, a recession with inflation is paradoxically an opportunity. Stocks fall, but historically the market recovers. Gold retains value when money depreciates. Foreign currencies can appreciate if your currency weakens. But you need to diversify because inflation hits differently depending on the sector.

What won’t change your life is the tax savings from deflating. We’re talking about hundreds of euros for the average person, not thousands. So if you expect this to revolutionize your investment capacity, probably not. But as an indicator that governments recognize the problem of eroded purchasing power, it’s relevant.

In short, understanding what deflated means and how it works in practice is useful for navigating complex economic scenarios. It’s not just theory; it has real implications for how you structure your portfolio and how the state tries (or doesn’t) to protect your consumption and investment capacity.