Optimal Taxation of Inflation

Abstract

This paper analyzes the effectiveness of a tax on inflation policy (TIP), which would require firms to pay a tax proportional to the increase in their prices or wages, in stabilizing inflation. We show that TIP would effectively correct externalities in firms' pricing decisions, tackle excessive inflation and reduce output volatility. While proposals from the 1970s saw TIP as a substitute for MP, we find that they are complementary, with TIP addressing cost-push shocks, and MP addressing demand shocks. In sharp contrast with price controls, TIP doesn't exacerbate relative price distortions. (JEL D21, D62, E12, E31, E52, E64, H21)