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Principles of Economics- Mankiw (5th) 626

Principles of Economics- Mankiw (5th) 626 - 646 PA R T T E...

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646 PART TEN MONEY AND PRICES IN THE LONG RUN The taxes on nominal capital gains and on nominal interest income are two examples of how the tax code interacts with inflation. There are many others. Because of these inflation-induced tax changes, higher inflation tends to discour- age people from saving. Recall that the economy’s saving provides the resources for investment, which in turn is a key ingredient to long-run economic growth. Thus, when inflation raises the tax burden on saving, it tends to depress the econ- omy’s long-run growth rate. There is, however, no consensus among economists about the size of this effect. One solution to this problem, other than eliminating inflation, is to index the tax system. That is, the tax laws could be rewritten to take account of the effects of inflation. In the case of capital gains, for example, the tax code could adjust the purchase price using a price index and assess the tax only on the real gain. In the
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