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Capital Income Taxes and the Benefit of Price Stability

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  • Martin Feldstein

Abstract

Going from low inflation to price stability involves a short term loss (associated with the" higher unemployment rate required to reduce the inflation) and results in a series of welfare gains" in all future years. The primary source of these gains is the reduction in the distortions that result" from the interaction of tax rules and inflation. The paper quantifies the gains associated with" reducing the distortion in favor of current consumption rather than future consumption and in" favor of the consumption of owner occupied housing. These tax effects are much larger than the" effect on the demand for money that is generally emphasized in studies of the distorting effect of" inflation. The seignorage gains are also small in comparison to other effects of the tax-inflation" interaction. The estimates imply that the annual value of the net benefits of going from two" percent inflation to price stability are about one percent of GDP. Discounting this growing" stream of benefits at a real discount rate of five percent implies a net present value of about more" than 30 percent of GDP. All estimates of the short-run cost of going from low inflation to price" stability are less than this.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6200.

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Date of creation: Sep 1997
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Publication status: published as The Costs and Benefits of Price Stability. Felstein, Martin, ed., Chicago: The University of Chicago Press, 1999, pp. 9-40.
Handle: RePEc:nbr:nberwo:6200

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  1. Robert J. Barro, 2012. "Inflation and Economic Growth," CEMA Working Papers, China Economics and Management Academy, Central University of Finance and Economics 568, China Economics and Management Academy, Central University of Finance and Economics.
  2. Martin Feldstei & Jerry Green & Eytan Sheshinski, 1978. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," NBER Chapters, in: Research in Taxation, pages 53-70 National Bureau of Economic Research, Inc.
  3. Martin Feldstein, 1995. "Tax Avoidance and the Deadweight Loss of the Income Tax," NBER Working Papers 5055, National Bureau of Economic Research, Inc.
  4. Harvey S. Rosen, 1983. "Housing Subsidies: Effects on Housing Decisions, Efficiency, and Equity," NBER Working Papers 1161, National Bureau of Economic Research, Inc.
  5. N. Gregory Mankiw, 1987. "Consumer Spending and the After-Tax Real Interest Rate," NBER Chapters, in: Taxes and Capital Formation, pages 97-100 National Bureau of Economic Research, Inc.
  6. Poterba, James M, 1992. "Taxation and Housing: Old Questions, New Answers," American Economic Review, American Economic Association, vol. 82(2), pages 237-42, May.
  7. James M. Poterba, 1983. "Tax Subsidies to Owner-occupied Housing: An Asset Market Approach," Working papers 339, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Feldstein, Martin, 1995. "Fiscal policies, capital formation, and capitalism," European Economic Review, Elsevier, vol. 39(3-4), pages 399-420, April.
  9. Feldstein, Martin S, 1979. "The Welfare Cost of Permanent Inflation and Optimal Short-Run Economic Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(4), pages 749-68, August.
  10. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
  11. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, vol. 75(1), pages 128-38, March.
  12. Stanley Fischer & Franco Modigliani, 1978. "Towards an understanding of the real effects and costs of inflation," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 810-833, December.
  13. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
  14. Martin Feldstein, 1996. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Working Papers 5469, National Bureau of Economic Research, Inc.
  15. Blinder, Alan S, 1975. "Distribution Effects and the Aggregate Consumption Function," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(3), pages 447-75, June.
  16. Martin Feldstein, 1978. "The Welfare Cost of Capital Income Taxation," NBER Chapters, in: Research in Taxation, pages 29-51 National Bureau of Economic Research, Inc.
  17. Benabou, Roland, 1992. "Inflation and Efficiency in Search Markets," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 59(2), pages 299-329, April.
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Cited by:
  1. Frederic S. Mishkin, 2000. "What should central banks do?," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 1-14.
  2. Monika Blaszkiewicz & Jerzy Konieczny & Anna Myslinskaa & Artur Radziwil & Przemyslaw Wozniak, 2003. "Some benefits of reducing inflation in transition economies," Macroeconomics, EconWPA 0303004, EconWPA.
  3. Stephen M. Miller & Luis F. Martins & Rangan Gupta, 2014. "A Time-Varying Approach of the US Welfare Cost of Inflation," Working Papers 201419, University of Pretoria, Department of Economics.
  4. Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One Decade of Inflation Targeting in the World: What Do We Know and What Do We Need to Know?," NBER Working Papers 8397, National Bureau of Economic Research, Inc.
  5. Martin Feldstein, 2002. "The Role for Discretionary Fiscal Policy in a Low Interest Rate Environment," NBER Working Papers 9203, National Bureau of Economic Research, Inc.
  6. António Portugal Duarte & João Sousa Andrade, 2012. "The Portuguese Public Finances and the Spanish Horse," EcoMod2012 3718, EcoMod.
  7. Leo Bonato, 1998. "The benefits of price stability: some estimates for New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 61, September.
  8. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  9. Mihir A. Desai & James R. Hines, Jr., 1999. "Excess Capital Flows and the Burden of Inflation in Open Economies," NBER Chapters, in: The Costs and Benefits of Price Stability, pages 235-272 National Bureau of Economic Research, Inc.
  10. William Poole, 1998. "Is inflation too low?," Speech, Federal Reserve Bank of St. Louis 87, Federal Reserve Bank of St. Louis.
  11. Pierre Fortin & George A. Akerlof & William T. Dickens & George L. Perry, 2002. "Inflation and Unemployment in the U.S. and Canada: A Common Framework," Cahiers de recherche du Département des sciences économiques, UQAM, Université du Québec à Montréal, Département des sciences économiques 20-16, Université du Québec à Montréal, Département des sciences économiques.
  12. William Poole, 1999. "Is Inflation Too Low?," Cato Journal, Cato Journal, Cato Institute, vol. 18(3), pages 453-464, Winter.
  13. Roger H. Gordon & Julie Berry Cullen, 2002. "Taxes and Entrepreneurial Activity: Theory and Evidence for the U.S," NBER Working Papers 9015, National Bureau of Economic Research, Inc.
  14. Honohan, Patrick, 2003. "Avoiding the pitfalls in taxing financial intermediation," Policy Research Working Paper Series 3056, The World Bank.
  15. Andrew Coleman, 2008. "Tax, Credit Constraints, and the Big Costs of Small Inflation," Working Papers, Motu Economic and Public Policy Research 08_14, Motu Economic and Public Policy Research.
  16. William Poole, 1999. "Is inflation too low?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 3-10.

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