What is the benefit to the government for issuing inflation-protected securities

[WilliamOfOckham]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

I'm not sure this is necessarily accurate for TIPS held in a tax-advantaged account. Of course tax will typically be paid at some point, but in terms of the payment not corresponding with the methodology, I cannot say that I'm following the suggestion.
viewtopic.php?p=2371309#p2371309

I agree my point is not true if these are held in a Roth IRA; otherwise, the tax keeps yield less than inflation regardless of methodology.

[saver7007]

Here is a press release item from 1997. Aside from the recent period, generally TIPS have ended up paying less than nominals historically. It remains to be seen what happens going forward, but here is one taxpayer justification.

How Treasury Has Benefited
As an issuer of the securities, Treasury is also happy with the program. We have established a program that, over the years, will cost the government and the taxpayers less than nominal debt. This will result from the government, instead of investors, taking the risk of inflation. In brief, we will receive the inflation risk premium instead of paying it. And we can bear the risk of inflation more efficiently than can any single investor, no matter how large.

https://home.treasury.gov/news/press-releases/rr1966

So in a nutshell the US Treasury "will receive the inflation risk premium instead of paying it", that's a difference in the returns of TIPS vs. nominal bonds that I didn't recognize. Maybe this explains why TIPS have actually returned less than nominal bonds as several people on this thread pointed out. I take it nominal bonds will generally return more than TIPS as long as inflation remains low, and the difference in return is the inflation risk premium, and also the existence of TIPS is a sign that the government is serious about keeping inflation low otherwise it would make no sense to issue them. For holders of TIPS the trade-off is that the return will be lower somewhat than nominals but you get protection in case inflation does run hot. I appreciate all the insightful answers on this thread, this is a great forum, thanks.

[exodusing]

TIPS differ from nominal treasuries in two important ways for investors. First, you are buying inflation protection. This costs something. Second, you are buying a security which is less liquid than nominal treasuries. You should expect to be paid for this lack of liquidity. A reasonable simplifying assumption is that the two effects essentially cancel each other out, but in practice one or the other is likely to be larger.

[alluringreality]

I agree my point is not true if these are held in a Roth IRA; otherwise, the tax keeps yield less than inflation regardless of methodology.

I guess it looks like Chained CPI might be used for tax bracket adjustment, while TIPS use CPI-U, so I suppose that might give a slight preference to Roth. Of course there seem to be edge cases with taxes, such as questioning if someone that can stay in the 12% bracket with traditional account contributions would necessarily want to pay 22% tax for a Roth.

[nisiprius]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

This is true of every investment. Tax is, alas, assessed on the increase in the number of dollars, not in real value. Yet this never seems to be brought up except when TIPS are being criticized, as if it were some special disadvantage of TIPS.

It is rare to see any chart of the historical return of stocks that takes taxes into account. To its credit, one edition of Stocks for the Long Run actually did include such a chart, the only one I think I've ever seen--but it is not in the current edition.

[retired@50]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

This is true of every investment. Tax is, alas, assessed on the increase in the number of dollars, not in real value. Yet this never seems to be brought up except when TIPS are being criticized, as if it were some special disadvantage of TIPS.

It is rare to see any chart of the historical return of stocks that takes taxes into account. To its credit, one edition of Stocks for the Long Run actually did include such a chart, the only one I think I've ever seen--but it is not in the current edition.

At least with stock funds you have a chance of out-performing inflation (i.e. gaining additional purchasing power), even after taxes.

Regards,

[WilliamOfOckham]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

This is true of every investment. Tax is, alas, assessed on the increase in the number of dollars, not in real value. Yet this never seems to be brought up except when TIPS are being criticized, as if it were some special disadvantage of TIPS.

It is rare to see any chart of the historical return of stocks that takes taxes into account. To its credit, one edition of Stocks for the Long Run actually did include such a chart, the only one I think I've ever seen--but it is not in the current edition.

No special criticism of TIPS was intended, other than that "inflation protected" is an overstatement for these and I bonds. Perhaps "somewhat inflation protected" or "sometimes inflation protected" would improve.

[retired@50]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

This is true of every investment. Tax is, alas, assessed on the increase in the number of dollars, not in real value. Yet this never seems to be brought up except when TIPS are being criticized, as if it were some special disadvantage of TIPS.

It is rare to see any chart of the historical return of stocks that takes taxes into account. To its credit, one edition of Stocks for the Long Run actually did include such a chart, the only one I think I've ever seen--but it is not in the current edition.

No special criticism of TIPS was intended, other than that "inflation protected" is an overstatement for these and I bonds. Perhaps "somewhat inflation protected" or "sometimes inflation protected" would improve.

Or, inflation protection minus taxes, unless held in a Roth.

Regards,

[AnnetteLouisan]

They were intended for small lower income savers originally I thought. That’s why the annual amount is limited.

[StrangePenguin]

From the LA Times in 1996:

Very helpful to dig out these articles, thank you.

[FoundingFather]

In an environment where bond yields had fallen from the teens to 6-7% over the previous 15 years, it's not unreasonable to think the government was looking for a way to get more people to invest in Treasury bonds, and news from the time backs up that they thought they could sell more bonds and overall it would be cheaper...

Very helpful quotations and perspectives - thank you!

Founding Father

[White Coat Investor]

It's easy to see the benefit of inflation protection for holders of TIPS and I Bonds, but what is the benefit to the government and to taxpayers for offering to cover the cost of future inflation? I can't figure it out, it appears one-sided. Also seeing that corporations don't generally issue inflation-indexed bonds makes me suspect they are probably not a great deal for issuers, but there must be some rationale for them.

If inflation is lower than expected or as expected, the government gets to borrow for less than it otherwise would have.

[NiceUnparticularMan]

TIPS are one of those things that sound good to have. Actually seemed like a no-brainer.
They have proven to be worse than useless after real inflation kicked in 2 years ago.
So apparently it did work well... for the government... not for the investor.
So much for all the TIPS discussions.

Did they fail? The government had to pay more interest. TIPS “failed” only because the market real yield increased. That is a big difference from being good for the government.

Yep.

In other words, liability-matched TIPS didn't fail.

But if you don't liability match--you roll your dice and take your chances.

[NiceUnparticularMan]

Here is a press release item from 1997. Aside from the recent period, generally TIPS have ended up paying less than nominals historically. It remains to be seen what happens going forward, but here is one taxpayer justification.

How Treasury Has Benefited
As an issuer of the securities, Treasury is also happy with the program. We have established a program that, over the years, will cost the government and the taxpayers less than nominal debt. This will result from the government, instead of investors, taking the risk of inflation. In brief, we will receive the inflation risk premium instead of paying it. And we can bear the risk of inflation more efficiently than can any single investor, no matter how large.

https://home.treasury.gov/news/press-releases/rr1966

That's definitely the theory, but in practice the observed inflation risk premium has been tiny, and sometimes actually negative (which is explainable as a liquidity premium going the other way).

[JoMoney]

Since CPI is a reported after-the-fact measurement, they get the usage of spending the dollars first and a delay in accruing the CPI indexed liability (that may be negative), and have the ability to choose how to tax the recipient on the payment. It's not necessarily a bad deal for the government, even if it's not clearly a benefit over nominal treasury debt.

[Ben Mathew]

Inflation indexed bonds provide inflation protection for both sides to the transaction--both the lender and the borrower know what they are going to get/pay in the future.

Nominal bonds introduce inflation risk for both sides of the transaction--neither the lender nor the borrower know what they are going to get/pay in the future.

So all loans and promises--treasury bonds, corporate bonds, personal loans to your nephew, pension payouts etc.--should have been made in real dollars, not nominal dollars. It's better for both sides ex ante. The reason it's not happening is money illusion.

Money illusion is pervasive and leads to poor financial decisions. One of the key goals of financial education should be to help people see through nominal dollars and think in inflation adjusted real dollars. Thinking in nominal dollars is a tough habit to break, given how ingrained nominal dollars is in our daily activities. But it does not serve us well in long term financial planning.

[Ben Mathew]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

I'm not sure this is necessarily accurate for TIPS held in a tax-advantaged account. Of course tax will typically be paid at some point, but in terms of the payment not corresponding with the methodology, I cannot say that I'm following the suggestion.
viewtopic.php?p=2371309#p2371309

I agree my point is not true if these are held in a Roth IRA; otherwise, the tax keeps yield less than inflation regardless of methodology.

It would apply to traditional IRAs too, since the tax will be paid in inflated dollars.

The traditional vs Roth difference will come down to the usual marginal tax rate comparison. There would be no difference in the after-tax returns of TIPS and nominals that paid the same inflation adjusted interest rate.

[WilliamOfOckham]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

I'm not sure this is necessarily accurate for TIPS held in a tax-advantaged account. Of course tax will typically be paid at some point, but in terms of the payment not corresponding with the methodology, I cannot say that I'm following the suggestion.
viewtopic.php?p=2371309#p2371309

I agree my point is not true if these are held in a Roth IRA; otherwise, the tax keeps yield less than inflation regardless of methodology.

It would apply to traditional IRAs too, since the tax will be paid in inflated dollars.

The traditional vs Roth difference will come down to the usual marginal tax rate comparison. There would be no difference in the after-tax returns of TIPS and nominals that paid the same inflation adjusted interest rate.

Thanks for the correction, and now I think I understand what alluringreality was getting at too.

[dml130]

Canada recently stopped issuing inflation-linked bonds.

If the US were to stop, it might be seen as a sign that we don't expect to get it under control.

So, what might happen to a TIPS fund (LTPZ, for example) if the US were to stop issuing TIPS? Liquidation of the fund?

[exodusNH]

Canada recently stopped issuing inflation-linked bonds.

If the US were to stop, it might be seen as a sign that we don't expect to get it under control.

So, what might happen to a TIPS fund (LTPZ, for example) if the US were to stop issuing TIPS? Liquidation of the fund?

I don't know the mechanics of it (alex_686 probably does), but you'd probably get the fund's NAV winding down to $0, paying out the matured bonds as dividends.

[JoMoney]

Canada recently stopped issuing inflation-linked bonds.

If the US were to stop, it might be seen as a sign that we don't expect to get it under control.

So, what might happen to a TIPS fund (LTPZ, for example) if the US were to stop issuing TIPS? Liquidation of the fund?

I don't know the mechanics of it (alex_686 probably does), but you'd probably get the fund's NAV winding down to $0, paying out the matured bonds as dividends.

I would expect more likely the fund would change it's objective to follow some other securities, or they'd merge it into a different fund that the operators thought likely to retain and gain new investors. Funds close all the time when assets start to fall below a level that's worthwhile to keep operating at. Investors would be bailing on the fund long before it wound down from assets maturing.

[student]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

This is true of every investment. Tax is, alas, assessed on the increase in the number of dollars, not in real value. Yet this never seems to be brought up except when TIPS are being criticized, as if it were some special disadvantage of TIPS.

It is rare to see any chart of the historical return of stocks that takes taxes into account. To its credit, one edition of Stocks for the Long Run actually did include such a chart, the only one I think I've ever seen--but it is not in the current edition.

No special criticism of TIPS was intended, other than that "inflation protected" is an overstatement for these and I bonds. Perhaps "somewhat inflation protected" or "sometimes inflation protected" would improve.

I have the same sentiment as you. Not quite inflation protected unless one is in the 0% bracket. In any case, I think TIPS is useful enough.

[dbr]

It remains a mystery why these are not labeled TIIS Treasury Inflation Indexed Securities. Reading labels on potential investments one might purchase is bad investing because it leads to bad thinking, whether it is the "protected" in TIPS or the "retirement" and date in a target retirement fund, or the "growth" in a growth fund or "value" in a value fund.

The TIPS instrument does what it does given whatever circumstances an investor is in. "Protected" is not a property of investments anymore than "safe" and a lot of other nonsense.

[exodusNH]

Canada recently stopped issuing inflation-linked bonds.

If the US were to stop, it might be seen as a sign that we don't expect to get it under control.

So, what might happen to a TIPS fund (LTPZ, for example) if the US were to stop issuing TIPS? Liquidation of the fund?

I don't know the mechanics of it (alex_686 probably does), but you'd probably get the fund's NAV winding down to $0, paying out the matured bonds as dividends.

I would expect more likely the fund would change it's objective to follow some other securities, or they'd merge it into a different fund that the operators thought likely to retain and gain new investors. Funds close all the time when assets start to fall below a level that's worthwhile to keep operating at. Investors would be bailing on the fund long before it wound down from assets maturing.

But since a comparable asset class no long exists, I bet they'd let it run down until the assets got small enough to not be worth administering.

[WilliamOfOckham]

It remains a mystery why these are not labeled TIIS Treasury Inflation Indexed Securities. Reading labels on potential investments one might purchase is bad investing because it leads to bad thinking, whether it is the "protected" in TIPS or the "retirement" and date in a target retirement fund, or the "growth" in a growth fund or "value" in a value fund.

The TIPS instrument does what it does given whatever circumstances an investor is in. "Protected" is not a property of investments anymore than "safe" and a lot of other nonsense.

I agree TIIS would be more accurate. Misleading labels often do just that. In this case I thought not actually being "inflation protected" helped answer the original question, how the government benefited from issuing such securities.

[SB1234]

Least I heard the government was for the people.

As in, "I'm from the government, and I'm here to help"?

No. as in
We the people ....