How Should Financial Intermediation Services be Taxed?

Journal article

This paper considers the optimal taxation of two types of financial intermediation services (savings intermediation, and payment services) in a dynamic general equilibrium setting, when the government can also use consumption and income taxes. When payment services are used in strict proportion to final consumption, and the cost of intermediation services is the same across firms, the optimal taxes on financial intermediation are generally indeterminate. But, when firms differ in the cost of intermediation services, the tax on savings intermediation should be zero. Also, when household time and payment services are substitutes in transactions, the optimal tax rate on payment services is determined by the returns to scale in the conditional demand for payment services, and is generally different to the optimal rate on consumption goods. In particular, with constant returns to scale, payment services should be untaxed. These results can be understood as applications of the Diamond-Mirlees production efciency theorem. The extension to n consumption goods in each period is also studied.

Authors: Lockwood, B

• Publication date: 2010-10-01