Score contribution per author:
α: calibrated so average coauthorship-adjusted count equals average raw count
This paper explores how the optimal mode of public finance depends on the level of economic development. The theoretical analysis suggests that in the presence of capital market imperfection and liquidity shocks, the detrimental effect of inflation on growth is stronger (weaker) at lower (higher) levels of economic development. Consequently, income taxation (seigniorage) is a relatively less distortionary way of financing public expenditure for low‐income (high‐income) countries. We provide empirical support for our model’s predictions using a panel of 21 Organization for Economic Cooperation and Development countries and 40 developing countries observed over the period 1972–1999. (JEL E44, E6, H6, O42)