IRPF Deflation: How can it affect your investment returns during inflationary times?

The Current Economic Context: Why Deflation Adjustment is Trending

At the end of 2022, Europe and the United States faced an unprecedented scenario in decades: a record inflation that forced central banks to aggressively raise interest rates. In Spain, inflation reached 6.8% by November 2022, constantly eroding the purchasing power of citizens and investors alike.

In response, governments and politicians revived a fiscal measure that had fallen into oblivion: fiscal deflation adjustment. This tool aims to protect taxpayers from a silent trap: when nominal wages (in numbers) increase, many citizens end up paying more taxes proportionally, losing even more real purchasing power.

What is deflating and why does it matter in your investment strategy?

Deflating is an economic concept that adjusts nominal figures to eliminate inflation noise. While nominal GDP can grow by 20%, if prices rose by 10%, the real growth is just 10%. Economists use deflators to compare the actual performance of an economy, company, or individual over time, without inflation distorting the numbers.

A practical example: A country produces 10 million euros worth of goods in year 1. The next year, production rises to 12 million, but prices increased by 10%. Without deflating, it appears that the economy grew by 20%, when in reality it only grew by 10%. This adjustment, which subtracts the impact of inflation, is called deflation adjustment.

In the Spanish tax realm, IRPF deflation adjustment goes further: it refers to readjusting the progressive tax brackets so that taxpayers do not pay more taxes simply because their nominal income grew along with inflation.

Deflated IRPF: the measure few understand but everyone should know

The Personal Income Tax (IRPF) is a progressive tax that levies on the income of Spanish residents. Its progressivity means that the higher the income, the higher the percentage of tax paid. Here’s the problem: when a worker receives a salary increase that simply maintains their purchasing power (because it adjusts to inflation), they technically move to a higher tax bracket, paying a higher rate even if their real situation did not improve.

The IRPF deflation adjustment recalibrates these brackets annually according to the CPI (Consumer Price Index). This ensures that a salary increase that only compensates for inflation does not generate additional tax burden.

International comparison:

• United States: has been deflating annually for decades
• France: applies annual deflation adjustment
• Nordic countries: integrated into their systems
• Germany: every two years
• Spain: has not applied national deflation adjustment since 2008, although some regional governments announced plans to adopt it

The impact on your investment portfolio

For investors, the deflation adjustment of IRPF has direct consequences:

Increased investable capital: If fewer taxes are applied to your income, you will have more capital available to invest. After-tax returns would especially improve in investments that generate regular income (dividends, rents, interests).

Demand for assets: A well-designed deflation adjustment could increase overall demand for investments, especially in sectors considered safe havens or green investments.

Unequal benefits: Paradoxically, the progressivity of IRPF means that higher-income taxpayers benefit more from deflation adjustment, even percentage-wise, concentrating fiscal advantages.

Investment strategies in an inflationary context

When inflation is high and interest rates rise, the equation changes for each asset class:

Commodities: gold as an anchor

Gold is historically the safe haven during high inflation. Not linked to any economy, it preserves value as money depreciates. In times of high interest rates, investors prefer it over government bonds (that are taxed in IRPF). Its short-term volatility is significant, but long-term it has always appreciated.

Stocks: selectivity is key

Inflation and high rates deteriorate corporate profits and make credit cheaper, putting downward pressure on stock prices. 2022 demonstrated this: the energy sector posted record profits while technology collapsed. Defensive companies (basic needs, energy) resist better than cyclical ones. For long-term investors with liquidity, price dips represent buying opportunities, as markets historically recover.

Forex: volatility and leverage

Currencies depreciate when inflation rises, making foreign exchange attractive. But forex is highly volatile, especially with leverage: small initial investments can generate disproportionate gains or losses. Only recommended for experienced investors.

Bonds and Treasury securities: safety with adjusted returns

They offer yields designed to compensate for inflation and are backed by governments, minimizing risk, though typically with more modest returns.

Diversification: true defense

The key in inflation: diversify. Different assets respond differently to inflationary pressures. A balanced portfolio combining defensive stocks, commodities, bonds, and international currencies spreads risk and optimizes after-tax returns.

Final reflection: deflation adjustment, real change or mirage?

Although the IRPF deflation adjustment nominally protects purchasing power, its actual economic benefits are modest: an average taxpayer saves only hundreds of euros. Expecting this measure to solely revolutionize national investment levels is naive.

However, combined with a context of high interest rates and fiscal pressure, every euro saved in taxes is capital available for resilient investment strategies. The real gain lies in combining deflation adjustment with intelligently diversified investments, leveraging sectoral selectivity and volatility as opportunities, not risks.

Deflation adjustment is not a magic solution, but in scenarios of persistent inflation, understanding its mechanism and using it strategically is part of sophisticated financial management that every modern investor must master.