infonet-economy

In economies with a low level of financial inclusion (FI), most activities are settled in cash and are thus more difficult to trace, record, and tax. I show theoretically that economies with inefficient financial technologies exhibit low levels of FI and of tax revenue and that using an inflation tax as an additional source of income improves welfare. Improvements in technology lead to a higher level of FI, increased tax revenue and lower (optimal) inflation. I test this prediction using panel data from a broad set of countries. The data show a strong and robust negative link between FI and inflation and a positive link between FI and tax revenue for developing countries.