Inflation and Capital Gains Taxes in a Small Open Economy
Charles Ka Yui Leung
The Chinese University of Hong Kong (CUHK) - Department of Economics
Government of Canada - Department of Monetary and Financial Analysis
International Review of Economics and Finance, Vol. 9, Issue 3
As the financial markets mature in a modern economy, capital gains tax concerns arise naturally among economists as well as policy makers. This paper intends to investigate the distortions of capital gains tax in an inflationary environment. We develop a dynamic general equilibrium, life-cycle model in which capital formation or investment is an important channel for consumption smoothing. Since capital gains are taxed only at realizations, capital gains tax would distort the whole consumption path in general. In addition, inflation introduces an upward bias in the capital gains calculation and hence the co-existence of inflation and capital gains tax could amplify the distortions and leads to a great social welfare cost. We find that it is indeed the case.
Note: This is a description of the paper and not the actual abstract.
Keywords: amplifying effect, capital gains tax, inflation, welfare cost
JEL Classification: E51, E52, G18, H20Accepted Paper Series
Date posted: June 29, 2000
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