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Tax Distortions from Inflation: What are They? How to Deal with Them?

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  • Sebastian Beer
  • Mr. Mark E Griffiths
  • Mr. Alexander D Klemm

Abstract

Expected inflation has few real effects in purely private economies, but this is not the case when the tax system is not neutral with respect to inflation. In practice, tax systems are not neutral—though some have attempted to be so in the past—and this paper provides a comprehensive overview of the most relevant non-neutralities drawing both on existing literature and showing new illustrations and evidence of the effects. The paper shows, for example, how taxing inflationary gains can have tremendous impact on effective tax rates—even at relatively low rates of inflation. It also shows how partial adjustment—for only some types of incomes—can create additional distortions. A new empirical analysis reveals how the erosion of the value of depreciation allowances through inflation affects investment. Finally the paper discusses policy options to address such non-neutralities.

Suggested Citation

  • Sebastian Beer & Mr. Mark E Griffiths & Mr. Alexander D Klemm, 2023. "Tax Distortions from Inflation: What are They? How to Deal with Them?," IMF Working Papers 2023/018, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2023/018
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    References listed on IDEAS

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    1. Devereux, Michael P & Griffith, Rachel, 2003. "Evaluating Tax Policy for Location Decisions," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(2), pages 107-126, March.
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    7. Ruud A. De Mooij, 2012. "Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions," Fiscal Studies, Institute for Fiscal Studies, vol. 33(4), pages 489-512, December.
    8. Crane, Steven E & Nourzad, Farrokh, 1986. "Inflation and Tax Evasion: An Empirical Analysis," The Review of Economics and Statistics, MIT Press, vol. 68(2), pages 217-223, May.
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    Cited by:

    1. Bańkowski, Krzysztof & Checherita-Westphal, Cristina & Jesionek, Julia & Muggenthaler, Philip & Frutos, Mario Alloza & Avgousti, Aristoklis & Briodeau, Clémence & Brusbārde, Baiba & Caprioli, Francesc, 2023. "The effects of high inflation on public finances in the euro area," Occasional Paper Series 332, European Central Bank.
    2. Dubravko Mihaljek, 2023. "Inflation and public finances: an overview," Public Sector Economics, Institute of Public Finance, vol. 47(4), pages 413-430.

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    More about this item

    Keywords

    Tax policy; inflation; bracket creep.; expected inflation; NPV of depreciation; impact of inflation; tax distortions from inflation; savings income; cost of capital; rate of return; Depreciation; Income tax systems; Non-wage benefits; Income; Africa; Global;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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