Among the distortions generated by inflation, those caused by its interaction with taxation are particularly important. Due to the non-indexation of the tax system, inflation exacerbates the inefficiencies generated by taxation. The aim of this paper is to evaluate the welfare effects of these distortions in New Zealand. By using a stylised model of the New Zealand tax system, the tax burden on capital income is calculated for different values of the inflation rate. Following Feldstein (1997a, 1997b), the paper then estimates the welfare effects of going from 2 percent `true' inflation (net of measurement bias) to price stability. The benefits turn out to be about 0.4 percent of GDP, approximately half the size of those calculated by Feldstein for the US, the difference being mainly due to a less distortionary tax system. The permanent benefits are then compared with the one-off output loss that would be involved. As for the US, the result is supportive of price stability, but it does not hold for plausible values of some key parameters.
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Find related papers by JEL classification: E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook H2 - Public Economics - - Taxation, Subsidies, and Revenue
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