Abstract
Inflation magnifies the distorting effects of taxation when the tax treatment of interest income and expense is not fully indexed to inflation. The distortion involves a real interest tax wedge which is the difference between the real before tax interest rate that influences fully taxed investors and the real after tax interest rate that influences savers. Reducing the real tax wedge by eliminating inflation or indexing would stimulate private saving and non-residential investment, but decrease tax receipts and the tax deductions that subsidize home ownership.
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