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The optimal mix of taxes on money, consumption and income

  • Fiorella De Fiore
  • Pedro Teles

We determine the optimal combination of taxes on money, consumption and income in transactions technology models where exogenous government expenditures must be financed with distortionary taxes. We show that the optimal policy does not tax money, regardless of whether the government can use as alternative fiscal instruments an income tax, a consumption tax, or the two taxes jointly. These results are at odds with recent literature. We argue that the reason for this divergence is an inappropriate specification of the transactions technology adopted in the literature.

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Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-02-03.

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Date of creation: 2002
Date of revision:
Handle: RePEc:fip:fedhwp:wp-02-03
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  1. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimality of the Friedman rule in economies with distorting taxes," Staff Report 158, Federal Reserve Bank of Minneapolis.
  2. Fiorella De Fiore & Pedro Teles, 2002. "The optimal mix of taxes on money, consumption and income," Working Paper Series WP-02-03, Federal Reserve Bank of Chicago.
  3. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
  4. Vegh, Carlos A., 1989. "The optimal inflation tax in the presence of currency substitution," Journal of Monetary Economics, Elsevier, vol. 24(1), pages 139-146, July.
  5. R. Anton Braun, 1994. "Another attempt to quantify the benefits of reducing inflation," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 17-25.
  6. Barro, Robert J, 1976. "Integral Constraints and Aggregation in an Inventory Model of Money Demand," Journal of Finance, American Finance Association, vol. 31(1), pages 77-88, March.
  7. Casey B. Mulligan & Xavier Sala-i-Martin, 1997. "The optimum quantity of money: Theory and evidence," Economics Working Papers 229, Department of Economics and Business, Universitat Pompeu Fabra.
  8. Guidotti, Pablo E., 1989. "Exchange rate determination, interest rates, and an integrative approach to the demand for money," Journal of International Money and Finance, Elsevier, vol. 8(1), pages 29-45, March.
  9. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers 200105, Rutgers University, Department of Economics.
  10. Isabel Correia & Pedro Teles, 1999. "The Optimal Inflation Tax," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(2), pages 325-346, April.
  11. Avinash K. Dixit, 1990. "The Optimal Mix of Inflationary Finance and Commodity Taxation with Collection Lags," IMF Working Papers 90/87, International Monetary Fund.
  12. Casey B. Mulligan & Xavier Sala-i-Martin, 1995. "Adoption of financial technologies: Implications for money demand and monetary policy," Economics Working Papers 134, Department of Economics and Business, Universitat Pompeu Fabra.
  13. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman Rule Optimal When Money is an Intermediate Good?," CEPR Discussion Papers 1287, C.E.P.R. Discussion Papers.
  14. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers 22, Massachusetts Institute of Technology (MIT), Department of Economics.
  15. Marshall, David A, 1992. " Inflation and Asset Returns in a Monetary Economy," Journal of Finance, American Finance Association, vol. 47(4), pages 1315-42, September.
  16. Isabel Horta Correia & Juan Pablo Nicolini & Pedro Teles, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," Working Papers w200303, Banco de Portugal, Economics and Research Department.
  17. De Fiore, Fiorella, 2000. "Can indeterminacy explain the short-run non-neutrality of money?," Working Paper Series 0032, European Central Bank.
  18. Guidotti, Pablo E. & Vegh, Carlos A., 1993. "The optimal inflation tax when money reduces transactions costs : A reconsideration," Journal of Monetary Economics, Elsevier, vol. 31(2), pages 189-205, April.
  19. Jovanovic, Boyan, 1982. "Inflation and Welfare in the Steady State," Journal of Political Economy, University of Chicago Press, vol. 90(3), pages 561-77, June.
  20. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-78, June.
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