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Capital Gains and Inflation Taxes in a Life-cycle Model


  • Leung, C.
  • Zhang, G.-J.


Inflation distorts an economy through many channels. This paper highlights the interaction between inflation and capital gains tax and how they distort an economy through the financial market. Several observations motivate this research. First, capital formation or investment is an important channel for economic agents to smooth their consumption over their life cycles. Second, capital gains are taxed only when the gains are realized. Third, inflation introduces an upward bias in the calculation of the tax base. Thus, a capital gains tax in the presence of inflation can have a large welfare effect even though its contribution to the government revenue is relatively small. This paper supplements the literature on the overlapping generations model with money. In a world with imperfect capital markets where all agents consume cash goods, inflation transfers purchasing power from cash-rich generations to cash-poor generations who suffer more from liquidity constraints. This observation makes the welfare analysis here more interesting.

Suggested Citation

  • Leung, C. & Zhang, G.-J., 1999. "Capital Gains and Inflation Taxes in a Life-cycle Model," Staff Working Papers 99-2, Bank of Canada.
  • Handle: RePEc:bca:bocawp:99-2

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    References listed on IDEAS

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    Cited by:

    1. Leung, Charles Ka Yui & Zhang, Guang-Jia, 2000. "Inflation and capital gains taxes in a small open economy," International Review of Economics & Finance, Elsevier, vol. 9(3), pages 195-208, July.

    More about this item


    Inflation: costs and benefits;

    JEL classification:

    • 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


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