Inflation and Taxation with Optimizing Governments

This paper examines the empirical validity of the prediction that if governments minimize the deadweight loss from raising revenue through inflation and tax finance, there should be a positive contemporaneous association between inflation and the level of tax burdens. We examine the empirical validity of this prediction using data from Britain, France, Germany, Japan, and the United States. Inflation and tax rates are as likely to be negatively as positively correlated, so the results cast doubt on the empirical relevance of simple models in which governments with timeinvariant tastes choose monetary policy to equate the marginal deadweight burdens of inflation and taxes.