of Inflation and Taxes     Low Higher   Inflation Inflation Nominal T-bill yield 3.00% 6.00% Expected inflation 2.00 5.00 Real return 1.00 1.00 Taxes at 40% 1.20 2.40 After-tax nominal 1.80 3.60 After-tax real -0.20 -1.40 Real after-tax returns will tend to decline in inflationary periods because taxes are levied on nominal returns. Short-term interest rates often move with the expected rate of inflation. Assume Treasury bill rates are 1 percent above the expected rate of inflation and thus provide a 1 percent real pretax return. Table 30.4 shows that an increase in the expected rate of inflation will lead to a decline in real aftertax returns even if real pretax returns are unchanged. On an after-tax basis neither cash nor bonds have done much to help an investor grow the purchasing power of his or her estate. Stocks, however, have provided growth in real value. Figure 30.1 visually demonstrates the significant differences between nominal, real, and real after-tax returns. Notice how the relationship between 12% 10% 6% 4% 2% 0% Stock:. Bonds Bills -2% FIGURE 30.1 Returns 1926 through 2001 Source: Nominal and inflation data from Ibbotson Associates; tax adjustments by Goldman Sachs.