Journal of Tax Research

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Corruption affects government finance and inflation tax level in different ways. According to the Optimal Government Finance Theory (Phelps, 1973 Helpman and Sadka, 1979), government as a rational agent uses different revenue sources to the extent that the total distortion effect of its financing is minimized. To achieve this, the marginal cost of inflation tax should be equal to the marginal cost of direct and indirect taxes. We expect that for an economy with high levels of corruption, ceteris paribus, the marginal cost of direct and indirect taxes is relatively high compared to the marginal cost of the inflation tax. A sample of 110 countries has been used to extract the empirical results. The main results have been obtained through using the Control of Corruption Index (CCI) for the period 1996- 2009. The empirical findings support our hypothesis. A higher level of corruption results in higher inflation tax. In order to check the robustness of our results, the main hypothesis has been examined by using Corruption Perception Index (CPI) for the period 2001- 2009. The results are the same. Moreover, the findings show that the effect of corruption on inflation tax is greater in developing countries.

Keywords: Inflation tax, Optimal Government Finance Theory

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