Describe how inflation interacts with the tax system to distort savings and thus affect investment. Is this problem more severe now or less severe than it has been in the prior 20 years? Why?
What will be an ideal response?
The government taxes nominal income rather than real income. As a result, when we account for inflation, the effective real tax rate is much higher than the stated tax rate because the government is taxing nominal income, including income received to compensate for inflation. This higher effective tax rate reduces incentive to save, so it hurts investment, reducing future capital stock and output.However, the problem is less severe now since inflation is low and there are more avenues for tax-advantaged investing.??
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