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On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation

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  • Carlos E. da Costa
  • Iván Werning

Abstract

We study the optimal inflation tax in an economy with heterogeneous agents subject to nonlinear taxation of labor income. We find that the Friedman rule is Pareto efficient when combined with a nondecreasing labor income tax. In addition, the optimum for a utilitarian social welfare function lies on this region of the Pareto frontier. The welfare costs from inflation are bounded below by the area under the demand curve. (c) 2008 by The University of Chicago. All rights reserved.

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  • Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 82-112, February.
    • Handle: RePEc:ucp:jpolec:v:116:y:2008:i:1:p:82-112
    DOI: 10.1086/529397
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