In the grand narrative of our modern age, a comforting story is often told: the rise of the welfare state has empowered the less fortunate, granting them opportunities that their circumstances had denied them. It’s a tale of progress, of societies building vast infrastructures of compassion—social safety nets, public education, healthcare, and pensions—all designed to lift up the disadvantaged and smooth out the harsh edges of capitalism. With each passing year, these systems have grown in size and scope, managing and spending ever-increasing sums of our collective wealth, all under the noble banner of redistribution. And yet, a stark and unsettling reality haunts this story: even as the machinery designed to fight inequality has become larger and more powerful than ever, the gap between the haves and the have-nots continues to widen.
How can this be? How can we be investing unprecedented resources to close the divide, only to watch it grow?
My colleague, Leon Österman, and I addressed this very question in our recent thesis, “Monetary Expansion, Inequality, and the Politics of Revenue Extraction”. Our work began by noting a curious blind spot in the mainstream critiques of inequality offered by prominent thinkers like Branco Milanovic, Thomas Piketty, and Emmanuel Saez and Gabriel Zucman. Their analyses tend to focus intensely on the structural features of capitalism that concentrate wealth—which, although true, a closer look shows that the hands accumulating that wealth change quite rapidly over time.
Yet all this writing completely ignores the active role that governments (not capitalism) play in widening the gap through their control of the monetary system. This omission is critical because not all inequality is created equal. There is a profound philosophical difference between wealth disparities that arise from voluntary exchange and those created by government decree. One could argue that inequality born from innovation and successfully serving the needs of others is not only justifiable but is the very engine of societal progress; it rewards value creation and incentivizes excellence. However, inequality born from a government’s monopoly over currency issuance—a power no one else can legally wield—is fundamentally unjust. It creates a rigged game, where political insiders and those closest to the monetary spigot gain a coercive advantage at the expense of everyone else.
With this in mind, we find it necessary to turn our focus toward an alternative explanation for growing inequality—one that shifts attention from the structural tendencies of capitalism, to the fiscal and monetary strategies of governments themselves. When states resort to consistent debt monetization and large-scale borrowing, they trigger inflation that erodes the purchasing power of those least able to protect themselves. At the same time, these policies inflate asset prices, disproportionately benefiting those who already hold wealth, while channeling resources from late recipients of money (wage earners, the working class) toward early recipients such as banks, contractors, and financial institutions. On the surface, this dynamic seems to run directly counter to the redistributive ambitions of the welfare state. How can governments pour billions into welfare programs while simultaneously pursuing monetary and fiscal strategies that blunt or even reverse their intended effects?
To resolve this paradox, it is necessary to shift our analytical lens: Instead of viewing the state through the idealized prism of the social contract—a benevolent guardian of the common good—one should turn to Margaret Levi’s The Predatory Theory of Rule, which offers a more realistic perspective. Levi portrays the state as a rational, predatory actor whose overriding aim is not maximizing social welfare but maximizing its own command of resources. From this vantage point, a heavy reliance on overt taxation is politically dangerous: few electorates would tolerate losing 60, 70, or 80 percent of their income to the state. Thus, to avoid open resistance, governments turn to subtler instruments of revenue extraction. Monetary expansion, unlike taxation, disguises the true burden of state spending. Its costs emerge only with time, as inflation quietly redistributes wealth and obscures the causal link between policy and hardship. Seen in this light, the paradox dissolves. What appears to be a contradiction is, in fact, a calculated feature of modern statecraft.
The Illusion of Free Spending
The heart of the issue lies in a simple, yet often ignored, reality of government finance: every dollar a government spends must come from somewhere. For the better part of the last half-century, most governments have consistently spent more than they collect in taxes. We fundamentally live in the world of the budget deficit, where only a handful of countries can boast of sustained budget surpluses. To cover this shortfall, they are left with two fundamental choices beyond direct taxation: borrow money or create it. They do both voraciously.
By issuing bonds, governments borrow on a massive scale, promising to pay the money back decades from now. Simultaneously, they turn to their central banks to monetize these deficits, creating new currency to purchase the government’s own debt. This constant expansion of the money supply—the dollars, euros, yen, and so on, flowing into the global economy—is the hidden engine of a vast, regressive redistribution of wealth. While it allows governments to finance their ever-growing expenditures without the immediate political backlash of raising taxes, it unleashes economic forces that quietly concentrate wealth at the top and erode the purchasing power of everyone else.
The Cantillon Effect: An Old Truth in a Modern World
This is not a new phenomenon. As far back as the 18th century, economists like Richard Cantillon and David Hume observed that new money is never neutral. Cantillon, observing the effects of the gold mining industry of his day, noted a peculiar pattern: the first people to get their hands on the new money—the mine owners, the financiers, the merchants—were able to spend it at current, pre-inflation prices. As that new money circulated, it bid up the prices of goods and services. By the time it trickled down to the wage-earner or the farmer, their cost of living had already risen, diminishing the value of their labor and savings.
This phenomenon, now known as the “Cantillon Effect,” is alive and well today, although, instead of gold mines, the sources of new money are central banks and the financial system. In his book, Money, Inflation, and Business Cycles, economist Arkadiusz Sieroń masterfully outlines five mechanisms through which this process unfolds in modern economies, systematically making the rich richer and the poor poorer.
- Early vs. Late Recipients: New money enters the economy through specific channels—government contracts, bank loans, and financial markets. The individuals and institutions closest to these taps (banks, large corporations, asset holders) get to spend, invest, and profit before the inflationary wave hits the broader economy. Those on fixed incomes or with stagnant wages are the last to see their earnings rise, by which time their real wealth has already been silently siphoned away.
- Creditworthiness and Collateral: As monetary expansion floods financial markets, it inflates the value of assets like stocks, bonds, and real estate. For the wealthy, who own the vast majority of these assets, this is a boon. Their collateral swells, increasing their creditworthiness and allowing them to borrow more money at favorable rates to leverage into even greater wealth. For the average person with few or no financial assets, they have no such advantage; thus, their relative position deteriorates.
- Asset Price Inflation: Beyond collateral effects, asset owners directly benefit from rising stock, bond, and real estate prices. The value of what the rich own goes up. The value of what the poor earn—their labor—does not keep pace, leaving them in a relatively worse position.
- The Consumption Trap: Inflation does not hit all goods and services equally. Prices for basic necessities like food and energy—which constitute a much larger portion of a low-income family’s budget—often rise first and fastest. For wealthier households, such expenditures are only a small fraction of their income. This acts as a regressive tax, disproportionately eroding the purchasing power of the most vulnerable households.
- The Great Debtor’s Game: Inflation systematically benefits debtors at the expense of creditors. Since debts are typically paid back in fixed nominal amounts, the real value of that debt diminishes over time as the currency loses its value. And the greatest debtor of all is the government itself. Through inflation, governments effectively reduce the real burden of their own massive debts, a cost borne by savers and anyone holding the currency.
Evidence from our Research
The mechanisms at hand play out with a significant force. For instance, results from our research show that increases in the money supply correlated positively with future increases in inequality indicators such as the Gini coefficient. And yet our paper was just a small contribution to a decades-long body of literature pointing to the relationship between expansions of the money supply, the consequent inflation, and the regressive effects of those. The economic literature is clear on these effects. An expansion of the welfare state, if it is financed through the hidden tax of inflation, ends up entrenching the very disparities it is supposed to resolve.
The Political Calculus behind Monetary Expansion
One might object that this is all a tragic mistake. Perhaps policymakers simply fail to recognize the regressive nature of their financing strategies. But this explanation strains credulity.
Modern states are not run by amateurs. Ministries of finance and central banks are staffed by dozens of highly trained economists, many of whom must be familiar with the literature on inflation and redistribution. The Cantillon effect is not an obscure curiosity; it has been part of economic discourse since the Enlightenment and has been revisited repeatedly in modern research.
This leaves two possibilities. The first is that policymakers deliberately ignore the problem, prioritizing short-term political expedience over long-term distributive effects. The second is that they acknowledge the regressive effects but believe these are offset by the progressive redistributions achieved through welfare spending. The latter is plausible, but far from convincing. To assume that welfare transfers can neatly compensate inflation-induced regressive effects is to casually brush off large bodies of evidence suggesting severe and persistent negative effects deriving from inflation.
In any case, the apparent contradiction between welfare expansion and monetary and fiscal strategies that exacerbate inequality arises not from incoherence, but from the lens through which we analyze government finance. If we assume the state’s purpose is to maximize public welfare, the coexistence of redistributive spending and regressive financing seems baffling. However, as Levi’s The Predatory Theory of Rule suggests, the state is better understood as an entity seeking to maximize the amount of resources under its command, constrained only by the need to maintain legitimacy in the eyes of its citizens. From this perspective, the policies are not contradictory at all—they are perfectly consistent.
Welfare programs function as legitimacy-building devices. They project an image of the state as a benevolent protector, securing broad support and goodwill. The challenge then becomes how to extract resources from the citizenry for those and other less popular expenditures (such as wars) without jeopardizing that legitimacy. Here lies the genius of monetary expansion. Unlike taxation, which is direct, visible, and politically costly, inflation gets diffused. Its causes are murky, its effects delayed. Citizens may attribute rising prices to corporate greed, speculative markets, or global shocks, rather than to government policy. As James Buchanan observed, this creates a form of “fiscal illusion”: governments can spend far beyond their tax revenues while obscuring the real cost of their expenditures and shifting blame for the consequences elsewhere. In this way, the state simultaneously extracts resources and preserves the very legitimacy that enables it to extract more.
In our research, we actually put this theory to the test. We conducted a comparative analysis of U.S. wartime financing, examining how the government paid for its military engagements in relation to their popularity. The results were telling. During wars with high public support, such as World War II, the government was more willing to rely on direct and transparent taxation, confident that citizens would bear the visible costs. However, for unpopular conflicts like Vietnam, Iraq, and Afghanistan, the reliance on debt and money creation soared. The state hid the true cost of war from a public it knew would not approve, passing the bill to future generations and to the poor through the hidden tax of inflation.
All this is to say that the rising tide of inequality does not seem to be an accident. It is, in significant part, the consequence of a political choice—a choice to fund ambition with illusion, to trade transparency for convenience, and to finance the present by quietly taxing the future and the poor. No comforting narrative can disguise this forever. Sooner or later, we will have to confront the foundations of government finance if we are ever to achieve genuine fairness and accountability.
