At the Public Sector Economics virtual presentation on 16th January 2024, Sebastian Beer and Alexander Klemm from the IMF’s Fiscal Affairs Department presented their views on tax distortions created by higher inflation.

Based on the article published in the journal Public Sector Economics, Beer and Klemm provided an overview of how inflation affects the tax system, grouping distortions into three categories: (1) nominal parameters of the tax system; (2) timing issues; and (3) taxation of nominal rather than real income. While the first two issues can be resolved or alleviated through relatively simple measures, the latter are the most difficult to address comprehensively, and partial measures, such as adjustment only for capital gains, can increase non-neutralities. 

Empirical results suggest a negative impact of inflation on investment, implying that any gains from greater interest deductibility are outweighed by the erosion of investment allowances. Some broader tax reforms, such as corporate cash-flow taxes or ACE systems would not only address inflation, but also increase efficiency, as they tax only economic rents. As the authors illustrated, the impact of inflation on the effective taxation of savings can be quite large, even at relatively low inflation rates, so the issue should remain topical, even with recent declines in inflation. 

The presentation was moderated by Dubravko Mihaljek, from the Monetary and Economic Department at the Bank for International Settlements and co-editor of the Public Sector Economics journal. 

A recording and a presentation of this interesting lecture are also available.