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To control inflation and reduce consumption, the Central Banks increase interest rates (eg UK). Wouldn't it be more beneficial (improved public services and infrastructure) to increase consumption tax like VAT? Or other taxes? (I did have a search to see if something similar was asked but couldn't find it). With increasing rates it just feels like my bank (mortgage) is getting richer for nothing.

Wouldn't increasing tax control spending and consumption as well?

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    $\begingroup$ Perhaps someone will write a long answer comparing the effects of monetary policy (raising rates) versus fiscal policy (raising taxes). However may I point out that in practice, politicians decide tax policy, and then the central bank chooses an interest rate policy that achieves policy objectives given the chosen fiscal policy. For example part of the reason they are raising rates is because inflation spiked coming out of Covid, exacerbated (some would say) by generous fiscal policies to help people during Covid. $\endgroup$
    – dm63
    Jan 24, 2023 at 15:54
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    $\begingroup$ Hi, welcome to economics.se. Opinion based questions are off topic here. Can you reformulate the question in such a way that it does not ask about opinions? $\endgroup$
    – 1muflon1
    Jan 24, 2023 at 18:02
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    $\begingroup$ What exactly do you mean by "more beneficial"? $\endgroup$
    – BrsG
    Jan 24, 2023 at 19:17
  • $\begingroup$ Beneficial means incrementally productive save hours if you like yet with a higher benefactor and beneficiary less atomic use utility assuredly, yet perhaps your meaning is still on topic: "improved" meaning more use to benefit outcomes. $\endgroup$ Jan 31, 2023 at 15:52

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Taxes do not reduce inflation when government spends money they tax. Inflation dynamics can be described using Philip's curve:

$$\pi_t = \pi^*_t +\beta(y_t-y_n) + \epsilon_t$$

where $\pi_t$ is inflation $\pi^*$ inflation expectations, $y_t$ real output and $y_n$ natural output and $\epsilon_t$ is vector of shocks.

Now increasing taxes and funding infrastructure as you suggest, depending on macroeconomic parameters, could lead to increase in $y_t$ or keep it unchanged (since government spending is part of output), and because distortionary taxes such as VAT or income tax create deadweight loss they could actually lower potential output $y_n$ (depending on what they are spent on). Massive government spending could also potentially increase inflation expectations, even if it would not change them it would for sure not lower them.

Hence your proposal simply does not lower inflation.

In order to lower inflation through tax hikes, there would have to be only tax hike without government spending that money on public services. This would lower current $y_t$ and help reduce inflation. Moreover, it is well known rule in optimal taxation that distortions increase disproportionally with size of tax so this would not be solution if taxes get so high that they cause too large drop of $y_n$. US does not have that high taxes so they could increase them, but this extra tax could not be spent on any public services as you suggest but just locked on account not to be used.

Next, low interest rates both increase $\pi^*$ and $y_t$ so that would still be part of problem that would either have to be dealt with even higher increase in taxes.

Whether doing this is ‘beneficial’ depends on social welfare function that you use to analyze a problem. Under some arbitrary social welfare function anything you like can be beneficial.

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  • $\begingroup$ What would be effects on inflation if taxes were raised to pay off the federal debt? $\endgroup$ Jul 2, 2023 at 2:56
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    $\begingroup$ @Mallory-Erik depends on what kind of debt, and by how much. If they raise taxes to pay for privately held debt then still the answer above applies because repaying private debt is not deflationary, government has less cash to spend but private individuals have more cash to spend and less options to save, if they repay debt to central bank which destroys money then it would be possible as long as the deflationary pressure from money destruction is not offset by inflationary pressure caused by lower potential output as result of tax distortions $\endgroup$
    – 1muflon1
    Jul 2, 2023 at 9:23
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As suggested if taxes are increased governments are inclined to increase spending on such as health, lower income citizens, infractructure etc which could increase inflation and little accomplished. What if the new tax increase was directed to reduce the debt which is considered to be too high? Even better would to reduce the tax increases until the inflation has reached the ideal so-called of 2%. The taxes resulted are probably ten times larger and probably include almost everyone not just the overextended mortgage or borrowing few and would take effect in a month not years.

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Great question. We should increase certain taxes instead of just interest rates.

It may help to specify what tax to increase. Corporations set the price of their products. If inlation is increasing prices, then corporations are ultimately responsible for that part of inflation. Housing inflation is different. Higher housing prices come from people wealthy enough to purchase another home or pay over value for property. If taxes were increased on those two groups specifically, other taxes unchanged, that should curb inflation too.

Some corporations increased prices to survive, but most raised prices to make more profit. Corporate income and capital gains taxes are historically very low (in the US anyway). Rarely in the last 100 years has it been better to make profit and pocket it instead of invest in their company. (An exception being the 1920s.) Higher taxes on very large corporations would encourage them to spend their profit on higher wages, more employees, new equipment or any other reinvestment into their company (true capitalism). Generating large profits lets them buy smaller companies or competitors to buy sales and cut staff. Another use for large profits is to give it to shareholders. That can can exacerbate inflation if those shareholders then invest in commodities and drive up the price of oil, metals, or food.

Higher taxes would not necessarily lead to more spending. It should go to pay off debt and the deficit. Democrats may "tax and spend", but the Republicans have cut taxes and spent even more. The result is an astronomical federal deficit and debt. It made some companies and people rich, but we and our kids will have to pay it off someday.

If you want an example, look at the tax rates during the 1990s. Slightly higher taxes on the top brackets, regular inflation, high employment, and a balanced budget.

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Interest rates and extra taxes have too slow an impact on inflation.

Since Inflation is usually caused by inducement rather than natural causes, then lending to purchase from those causing the inflation should be curtailed, (ie those who have a reasonable control over their market, think monopolistic control). The impact would be quick. I know that this interferes with the free market advocates, but then so does an artificially high interest rate.

We may even think the unthinkable and break up those that have gotten to big for their britches, such as the breakup of AT&T.

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A question I have asked many times but not got an answer that makes sense to me. Increasing TAX keeps the money in the public purse for use in public services. Interest rates hikes and tax hikes have the same impact on inflation. They reduce ability to spend thus curbing inflation. So why not manage inflation with TAX, keeping money in the public purse rather than through interest rates where money goes to banks/shareholders?

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    $\begingroup$ "Interest rates hikes and tax hikes have the same impact on inflation. " <- can you please provide any source for that statement? That is not empirically or even theoretically true $\endgroup$
    – 1muflon1
    May 4, 2023 at 11:41

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