Working Paper: NBER ID: w2567
Authors: James M. Poterba; Julio J. Rotemberg
Abstract: This paper extends and evaluates previous work on the positive theory of inflation. We examine the behavior of governments concerned solely with minimizing the deadweight loss from raising revenue through inflation and tax finance. We show that both governments that can commit to future policy actions, as well as those that cannot precommit, will choose a positive contemporaneous association between inflation and the level of tax burdens. We examine the empirical validity of this prediction using data from Britain, France, Germany, Japan, and the United States. Inflation and tax rates are as likely to be negatively as positively correlated, so the results cast doubt on the empirical relevance of simple models in which governments with time-invariant tastes choose monetary policy to equate the marginal deadweight burdens of inflation and taxes.
Keywords: inflation; taxation; government behavior; deadweight loss; OECD countries
JEL Codes: E31; E62; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation rates (E31) | tax burdens (H22) |
| demand for revenue increases (H29) | inflation rates (E31) |
| demand for revenue increases (H29) | tax burdens (H22) |
| inflation rates (E31) | marginal social costs of revenue (H29) |
| tax burdens (H22) | marginal social costs of revenue (H29) |
| stock of nominal debt is large (H63) | temptation to inflate (E31) |
| temptation to inflate (E31) | inflation rates (E31) |
| temptation to inflate (E31) | tax burdens (H22) |