Crosscountry evidence on inflation and income inequality suggests that they are positively correlated. I explore the hypothesis that this correlation is the outcome of a distributional conflict underlying the determination of fiscal policy.

__________________________________________________________________________We study dynamic optimal taxation in a class of economies with private information. Constrained optimal allocations in these environments are complicated and history-dependent. Yet, we show that they can be implemented as competitive equilibria in market economies supplemented with simple tax systems. The market structure in these economies is similar to that in Bewley (1986): agents supply labor and trade risk-free claims to future consumption, subject to a budget constraint and a debt limit. Optimal taxes are conditioned only on two observable characteristics-an agent's accumulated stock of claims, or wealth, and her current labour income-and they are not additively separable in these variables. The marginal wealth tax is decreasing in labour income and its expected value is generally positive. The marginal labour income tax is decreasing in wealth.

We thank three anonymous referees and an editor for useful comments. Chari and Christiano thank the National Science Foundation for support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research, the Federal reserve Banks of Chicago or Minneapolis or the Federal Reserve System.