How the IRPF deflator impacts your investment portfolio during inflationary times

Understanding What the Deflator Is and Its Economic Mechanism

The inflation that characterized 2022 brought unprecedented decisions from central banks and governments: interest rate hikes in the United States and Europe to curb uncontrolled price increases. In this context, a crucial fiscal measure for investors emerges: the deflator, a tool that redefines how we evaluate real economic performance.

What exactly is the deflator? It is a statistical index that allows comparison of economic variables by eliminating the “noise” caused by price fluctuations. When analyzing income, wages, or investment returns, these nominal numbers can be misleading: a 10% salary increase could mean a real loss of purchasing power if inflation was 15%.

The deflator works by normalizing data relative to a reference base year. It takes the nominal value (the surface value) and adjusts it to reflect only volume changes, removing the effect of price variations. For example: if a country produced goods worth 10 million euros in year 1, and in year 2 reached 12 million, it might seem like a 20% growth. However, if prices increased by 10% during that period, the real economic growth was only about 10%. This adjusted figure is known as GDP real, while the 12 million without adjustment represents nominal GDP.

Economists widely use this mechanism to compare company returns, wage evolution, and investment yields over time, providing a more accurate view than raw numbers.

Deflating Income Tax (IRPF): Beyond the Theoretical Concept

In Spain, especially during the 2022 inflation that reached 6.8% in November, national and regional politicians promoted the debate on deflating the IRPF. This measure aims to adjust income tax brackets to prevent taxpayers from losing purchasing power.

The Personal Income Tax (IRPF) is a progressive tax that levies annual income of residents in Spain. Its bracket structure means that as nominal income increases, higher tax rates are applied. The problem arises when that salary increase is merely inflationary: a worker receives a 5% raise that only partially compensates for the 6.8% inflation but is taxed as if their economic situation had genuinely improved.

Deflating the IRPF involves recalibrating these brackets based on inflation or nominal income increase. Thus, someone whose salary rises due to inflation does not see their effective tax rate increase. Multiple countries implement this adjustment regularly: the United States does it annually, France and Nordic countries also apply annual corrections, Germany every two years. In Spain, at the national level, it hasn’t been done since 2008, although some autonomous communities have started to adopt it.

It is important to clarify that this measure is not perceived as a conventional tax cut but as a technical adjustment that only becomes evident in the annual income declaration.

Who Benefits and Who Questions This Policy?

Proponents of deflating the IRPF argue that it protects families’ purchasing power during inflationary crises, allowing them to cover basic expenses without further eroding their consumption capacity.

However, there are well-founded criticisms. Detractors point out that the measure creates inequality: since IRPF is progressive, those with higher incomes receive greater fiscal benefits in absolute terms. Additionally, they highlight an economic dilemma: loss of purchasing power dampens demand, which helps control the CPI; recovering it through fiscal deflation could reactivate demand and push prices upward again.

Another concern is the reduction of public revenues, which could limit funding for essential services like education and healthcare. It is worth noting that the economic benefits per taxpayer are not revolutionary: they range from hundreds of euros annually for the average person.

Implications for Your Investment Strategy in the Face of Inflation and Fiscal Restrictions

When combining high inflation, elevated interest rates, and possible IRPF deflation, the outlook for investors becomes complex. These factors affect different asset types differently.

Increased liquidity available for investment: If IRPF deflation is implemented, investors would retain more disposable income, potentially redirecting it toward investments. This could especially boost demand for yield-generating assets: stocks, real estate, cryptocurrencies. Investments targeting specific sectors could also benefit if the fiscal reform includes incentives for renewable energy or technological innovation.

Safe haven: commodities and gold

Gold is an excellent defensive asset in high-inflation environments with high interest rates. Unlike bonds that generate taxable income under IRPF, gold is not linked to any national economy and retains value when currency depreciates.

Historically, over the long term, gold has always increased in value. However, in the short and medium term, it exhibits considerable volatility. As an inflation hedge, it works better as a diversification component than as a dominant position.

Stock market volatility: opportunity for patient investors

Inflation and high interest rates typically pressure the stock market, reducing investors’ purchasing power and increasing corporate financing costs. 2022 proved this: tech companies plummeted while energy companies reached all-time highs.

However, within that chaos, crucial differences exist. Sectors that cover basic needs or produce goods in demand during uncertainty tend to resist better. More importantly: for long-term investors with available liquidity, stock declines present buying opportunities. Historically, stock markets recover and grow even after severe drops.

Currencies: the game of exchange rates

The forex market offers peculiar opportunities during inflation. Currencies of countries with high inflation tend to depreciate, making it attractive to buy foreign currencies from countries with controlled inflation. This allows taking advantage of relative appreciations.

But beware: the forex market is highly volatile and risky, especially without experience. Exchange rates fluctuate due to economic conditions, political events, and market sentiment. Typical leverage in forex amplifies gains but also severe losses.

Bonds and Treasury securities: inflation-adjusted returns

Low-risk assets like bonds and Treasury securities are designed to provide returns aligned with inflation, backed by sovereign guarantees. Although they offer lower volatility, their income generates IRPF taxation, which must be considered in the final profitability calculation.

Portfolio Construction in an Inflationary and Restrictive Policy Context

A defensive yet profitable strategy requires smart diversification. Inflation affects different assets unevenly, so the right mix mitigates risks:

Quality stocks: Companies with pricing power, resilient margins, and inelastic demand offer protection.

Selective commodities: Gold and energy as hedges, but not as dominant positions.

International component: Currencies of economies with controlled inflation diversify exchange rate risk.

Adjusted bonds: A smaller percentage of fixed income with inflation protection.

Remember that no investment is risk-free, and values fluctuate constantly. The impact of deflating the IRPF on your portfolio will depend on its magnitude, implementation, and your specific tax situation. Although it provides relief for available liquidity, it should not be seen as the sole catalyst for major strategic changes. The central premise remains valid: in inflation, seek assets that increase in value with prices, diversify according to your risk profile and time horizon, and be aware of how taxes erode your real returns.