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A QUANTITATIVE ANALYSIS OF TAX ENFORCEMENT AND OPTIMAL MONETARY POLICY

Published online by Cambridge University Press:  28 September 2012

Marcelo Arbex
Marcelo Arbex*
Affiliation:
University of Windsor
*
Address correspondence to: Marcelo Arbex, Department of Economics, University of Windsor, 401 Sunset Avenue, Windsor, Ontario. N9B 3P4, Canada; e-mail: arbex@uwindsor.ca.
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Abstract

This paper explores the consequences of tax enforcement policies for monetary policy. Agents may evade taxes by working in the informal sector, but they are detected with positive probability. Workers are rewarded with government benefits that are proportional to formal (taxed) work. When enforcement is imperfect and collecting taxes is costly, the optimal inflation rate is positive and inflation becomes a second-best tax. Deviations from the Friedman rule are optimal and depend on the tax enforcement policies. Using U.S. data, we compute the quantitative effect of different tax structures on inflation and interest rate. We show that different tax enforcement and government spending (benefits) policies induce different optimal outcomes for inflation and interest rates.

Keywords

Optimal Interest RateTax EnforcementInformal EconomyTax Evasion
Type
Articles
Information
Macroeconomic Dynamics , Volume 17 , Issue 5 , July 2013 , pp. 1096 - 1117
Copyright
Copyright © Cambridge University Press 2012 

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