Compared with, say minimum wage increases, how inflationary is progressive taxation?
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1$\begingroup$ Why would taxes be considered inflationary? Normally, the opposite would be conventionally be thought of as true. It would help if you could explain the logic behind the question - e.g., what is the baseline we are comparing progressive taxes against? $\endgroup$– Brian RomanchukCommented Sep 26, 2018 at 21:23
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$\begingroup$ @BrianRomanchuk Why would the opposite be true? If two equal value choices A and B are available whereby A is cheaper, then a tax on A increases makes people choose the suboptimal choice B thereby lowering their buying power. Taxation seems like such a tax on two labor choices A and B. $\endgroup$– Neil GCommented Sep 26, 2018 at 21:40
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$\begingroup$ Anyway, if you are right that taxation is not inflationary, would you be able to find a peer reviewed source, and add an answer with a short explanation? $\endgroup$– Neil GCommented Sep 26, 2018 at 21:41
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1$\begingroup$ @BrianRomanchuk Taxes truly are inflationary. The OP rightly points out that taxes lower people's purchase power. Milton Friedman is quoted here and in Devil Take The Hindmost saying that "inflation is taxation without legislation". $\endgroup$– Iñaki ViggersCommented Sep 26, 2018 at 22:30
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1$\begingroup$ If taxes were inflationary, then a country that abolishes taxes (and makes no other policy changes) would allegedly have an extremely low inflation rate. This is certainly not what the consensus believes - large fiscal deficits are deemed to be inflationary. The relationship between taxes and inflation is a huge, contested research area, and although my expertise is limited, not aware of anything that relates progressivity of the tax code and inflation. $\endgroup$– Brian RomanchukCommented Sep 27, 2018 at 10:42
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2 Answers
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This is almost a link only answer, but you are asking for peer reviewed sources in the comments.
Brian Romanchuk's statement that taxes are anti-inflationary also appears. (Attributed to 'conventional macro'.)
CAN INCOME TAX INCREASES BE INFLATIONARY? AN EXPOSITORY NOTE
Abstract
Conventional macroeconomics classifies an increase in the rate of income taxation as an anti-inflation device because it reduces aggregate demand. However, an income tax hike may also constrict aggregate supply, making the effect on the price level ambiguous on purely theoretical grounds. This phenomena is investigated in the context of the conventional Hicks-Hansen IS-LM model, and a sufficient condition for an income tax hike to reduce the equilibrium price level is found. It is argued that this condition is very likely to be satisfied by the U.S. economy.
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$\begingroup$ @NeilG I don't think you should accept this answer yet, I am guessing more knowledgeable people will give more detailed ones. $\endgroup$– GiskardCommented Sep 27, 2018 at 7:15
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1$\begingroup$ My statement was more an assertion about where I believed the consensus was. As I clarified in a later comment, abolishing taxes would raise the fiscal deficit, which the consensus would view as inflationary. (Presumably, there are some exceptions, as always in economic theory.) $\endgroup$ Commented Sep 27, 2018 at 10:45
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Taxation is deflationary. It's fiscal tightening. It reduces aggregate demand.
(You didn't mention government spending in the question, so I've assumed it's flat).
Inflation is an increasing amount of money chasing the same amount of goods (or variants of same).
Taxation reduces the amount of money in the economy. So there's less money chasing the same amount of goods. Hence it's deflationary.
As to the extent to which progressive taxation specifically, is more or less deflationary than flat or regressive taxation: if we accept the observation that marginal propensity to consume decreases with income, then progressive taxation is less deflationary than flat or regressive taxation.
If, instead of assuming government spending is flat, we assume that the government's net fiscal position is flat, i.e. spending changes to match tax revenue, then progressive taxation is likely to be inflationary relative to flat or regressive taxation, as the average propensity to consume of people on lower incomes tends to be higher than that of people on higher incomes. Whether the overall net effect of taxation is inflationary or deflationary, will depend on the exact nature of the government spending, and where the economy is in the cycle.
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1$\begingroup$ Doesn't government also spend the collected taxes though, thereby creating demand? Or is this a short run / ceteris paribus kind of deal? $\endgroup$– GiskardCommented Sep 27, 2018 at 7:16
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$\begingroup$ The question didn't mention anything about that, so I've assumed spending is flat. $\endgroup$– 410 goneCommented Sep 27, 2018 at 7:17