Income tax cuts and inflation in Ireland

Abstract

A two sector model of the Irish economy is used to analyse whether either temporarily or permanently deferring reductions in labour tax rates would cut inflation in the short run. If the deferral of tax cuts is seen as permanent, simulations indicate the demand reduction caused by the higher tax rate may outweigh the reduction in supply causing prices to fall. If the deferral of tax cuts is seen as temporary the supply side effects dominate and the price level will rise as long as labour's share of non-traded output is higher than labour's share of traded output. This indicates that the argument being made by some economists that reductions in income tax should be temporarily deferred to curb inflation may be misguided.