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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
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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," NBER Working Papers 4443, National Bureau of Economic Research, Inc.
  2. De Fiore, Fiorella & Teles, Pedro, 2002. "The optimal mix of taxes on money, consumption and income," Working Paper Series 0135, European Central Bank.
  3. De Fiore, Fiorella, 2000. "Can indeterminacy explain the short-run non-neutrality of money?," Working Paper Series 0032, European Central Bank.
  4. 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.
  5. 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.
  6. Casey B. Mulligan & Xavier X. Sala-i-Martin & Frederic S. Mishkin & Jonas D. M. Fisher, 1997. "The optimum quantity of money: theory and evidence," Proceedings, Federal Reserve Bank of Cleveland, pages 687-724.
  7. Isabel Correia & Pedro Teles, 1997. "The optimal inflation tax," Discussion Paper / Institute for Empirical Macroeconomics 123, Federal Reserve Bank of Minneapolis.
  8. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal fiscal and monetary policy: equivalence results," Staff Report 403, Federal Reserve Bank of Minneapolis.
  9. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 223-244, October.
  10. 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.
  11. 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.
  12. 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.
  13. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  14. 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.
  15. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers 22, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. 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.
  17. 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.
  18. Avinash Dixit, 1991. "The Optimal Mix of Inflationary Finance and Commodity Taxation with Collection Lags," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 643-654, September.
  19. 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.
  20. Mulligan, Casey B & Sala-i-Martin, Xavier, 1996. "Adoption of Financial Technologies: Implications for Money Demand and Monetary Policy," CEPR Discussion Papers 1358, C.E.P.R. Discussion Papers.
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