The Welfare Effects of Switching from Consumption Taxation to Inflation Taxation in Iran’s Economy

Document Type: Research Paper


1 Faculty of Economics and Political Sciences, Shahid Beheshti University Iran

2 Faculty of Administrative Sciences and Economics, University of Isfahan, Iran

3 Faculty of Administrative Sciences and Economics University of Isfahan, Iran


The net effects of switching from consumption taxation to inflation taxation on resource allocation and welfare crucially depend on production externalities. With elastic labor supply, raising inflation taxation decreases leisure, but increases the levels of real consumption, capital, and output. Moreover, this tax switch has two opposing effects on the level of real money balances: A positive effect through the rise in output caused by the faster nominal money growth and a negative one through the fall in the ratio of real money balances to output. In the absence of any production, externality the negative effect dominates the positive effect. The real effect of this tax switching on resource allocation depends on the behavior of labor supply. If there is not a trade-off between leisure and labor supply, then the real effect of switching to inflaction taxation on real consumption, capital and output would disappear. With elasticity of labor supply, the welfare effect of this tax switch is conditional on the production externality. In the absence of production externality, inflation taxation always reduces welfare. With a strong enough production externality, switching from consumption taxation to inflation taxation may raise welfare by correcting the under-investment of capital and the under-supply of labor.


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Volume 4, Issue 2
Summer and Autumn 2015
Pages 1-15
  • Receive Date: 15 February 2014
  • Revise Date: 19 July 2016
  • Accept Date: 21 September 2016