Should transactions services be taxed at the same rate as consumption?

Ben Lockwood and Erez Yerushalmi

No 1423, Working Papers from Oxford University Centre for Business Taxation

Abstract: This paper considers the optimal taxation of transactions services in a dynamic general equilibrium setting, where households use both cash and costly transactions services provided by banks to purchase consumption goods. With a full set of all tax instruments, the optimal tax structure is indeterminate. However, all optimal tax structures distort the relative costs of payment media, by raising the relative cost of deposits to cash. In the simplest optimal tax structure, the Friedman rule holds i.e. cash should be untaxed, and the rate of tax on transactions services can be higher or lower than the consumption tax. When parameters are calibrated to US data, simulations suggest that the transactions services tax should be considerably lower. This is because a transactions tax has a "double distortion": it distorts the choice between payment media, and indirectly taxes consumption. This contrasts with the special case of the cashless economy, when the first distortion is absent: in this case, it is optimal to tax transactions services at the same rate as consumption.

Keywords: financial intermediation services; tax design; banks; monitoring; payment services (search for similar items in EconPapers)
JEL-codes: G21 H21 H25 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-ban, nep-dge, nep-mfd and nep-pbe
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Citations: View citations in EconPapers (1)

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