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Cold Progression and its Effects on Income Distribution

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  • Burkhard Heer
  • Bernd Süssmuth

Abstract

We present new empirical evidence for the US economy that inflation reduces the inequality of the earnings distribution. The main mechanism emphasized in this paper is the tax income bracket effect. Governments only adjust the nominal income tax brackets slowly to a rise in prices, typically less often than once every other year in the US post-war history. We also develop a theoretical general equilibrium monetary model with income heterogeneity. In this model, the effect of higher inflation on income distribution is shown to be rather small. However, we find that a longer duration between two successive adjustments of the income tax schedule reduces employment, savings, and output significantly.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 951.

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Date of creation: 2003
Date of revision:
Handle: RePEc:ces:ceswps:_951

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Related research

Keywords: cold progression; inflation; income distribution; tax income brackets;

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References

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  1. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  2. Budd, Edward C & Seiders, David F, 1971. "The Impact of Inflation on the Distribution of Income and Wealth," American Economic Review, American Economic Association, vol. 61(2), pages 128-38, May.
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  5. Alan J. Auerbach & Daniel Feenberg, 2000. "The Significance of Federal Taxes as Automatic Stabilizers," NBER Working Papers 7662, National Bureau of Economic Research, Inc.
  6. Klaus Deininger & Lyn Squire, 1996. "A New Data Set Measuring Income Inequality," CEMA Working Papers 512, China Economics and Management Academy, Central University of Finance and Economics.
  7. Imrohoroglu, Ayse & Imrohoroglu, Selahattin & Joines, Douglas H, 1998. "The Effect of Tax-Favored Retirement Accounts on Capital Accumulation," American Economic Review, American Economic Association, vol. 88(4), pages 749-68, September.
  8. Bach, G L & Stephenson, James B, 1974. "Inflation and the Redistribution of Wealth," The Review of Economics and Statistics, MIT Press, vol. 56(1), pages 1-13, February.
  9. Javier Díaz-Giménez & Vincenzo Quadrini & José-Víctor Ríos-Rull, 1997. "Dimensions of inequality: facts on the U.S. distributions of earnings, income, and wealth," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 3-21.
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  11. Shorrocks, A F, 1976. "Income Mobility and the Markov Assumption," Economic Journal, Royal Economic Society, vol. 86(343), pages 566-78, September.
  12. Ana Casta¤eda & Javier D¡az-Gim‚nez & Jos‚-Victor R¡os-Rull, 1998. "Earnings and wealth inequality and income taxation: quantifying the tradeoffs of switching to a proportional income tax in the U.S," Working Paper 9814, Federal Reserve Bank of Cleveland.
  13. Morten O. Ravn & Harald Uhlig, 2002. "On adjusting the Hodrick-Prescott filter for the frequency of observations," The Review of Economics and Statistics, MIT Press, vol. 84(2), pages 371-375.
  14. Gouveia, Miguel & Strauss, Robert P., 1994. "Effective Federal Individual Tax Functions: An Exploratory Empirical Analysis," National Tax Journal, National Tax Association, vol. 47(2), pages 317-39, June Cita.
  15. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  16. Hongyi Li & Lyn Squire & Tao Zhang & Heng-fu Zou, 1999. "A Data Set on Income Distribution," CEMA Working Papers 575, China Economics and Management Academy, Central University of Finance and Economics.
  17. Ales Bulir & Anne Marie Gulde, 1995. "Inflation and Income Distribution - Further Evidence on Empirical Links," IMF Working Papers 95/86, International Monetary Fund.
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Cited by:
  1. Stuart J. Fowler, 2005. "Income Inequality, Monetary Policy, and the Business Cycle," Computing in Economics and Finance 2005 184, Society for Computational Economics.
  2. Emiel Afman, 2005. "WP 38 - Income distribution in the Netherlands in the 20th century: long-run developments and cyclical properties," AIAS Working Papers wp38, AIAS, Amsterdam Institute for Advanced Labour Studies.

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