Abstract/Index

This paper studies the efficient taxation of money and factor income in intertemporal optimizing growth models with infinite horizons, transaction costs technologies and flexible prices. Second-best optimality calls for a positive inflation tax and a non-zero capital income tax when there are restrictions on taxation of production factors or profits/rents. Our cases of nonoptimality of the Friedman rule —which differ from those of Mulligan and Sala-i-Martin (1997) and extend substantially those of Schmitt-Grohè and Uribe (2004a)— follow from the violation of the Diamond and Mirrlees (1971) principle on production efficiency.