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The Decline in Aggregate Share Values: Inflation, Taxation, Risk and Profitability


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  • Patric H. Hendershott


With a neutral tax system an increase in observed and anticipated inflation would not be expected to alter either real after-tax yields on bonds and equities or the ratio of the market value of equities to the replacement cost of corporate real capital. In the real world, however, declines in real after-tax bond yields and the relative value of shares have been observed. Feldstein (1976, 1978) has attributed both of these phenonema to the use of historic-cost depreciation, and the taxation of nominal capital gains. Our analysis supports his conjecture regarding the decline in real after-tax debt yields, but rejects his analysis of the cause of the decline in share values. The decline in share values can be attributed to many factors, but the most important is probably the favorable taxation of income from owner-occupied housing (no taxation of either implicit rents nor real capital gains). As a result housing has become more attractive with the acceleration of inflation, and households have substituted housing for equity shares. Other possible sources of the decline in share values are reduced profitability of existing capital, owing to increased regulatory costs and real energy prices, and a greater perceived risk in business operations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0370.

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Date of creation: Jul 1979
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Publication status: published as Hendershott, Patric H. "The Decline in Aggregate Share Values: Taxation, Valuation Errors, Risk and Profitability." American Economic Review, (December 1981), pp. 909-922.
Handle: RePEc:nbr:nberwo:0370

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  1. Feldstein, Martin, 1980. "Inflation and the Stock Market," American Economic Review, American Economic Association, vol. 70(5), pages 839-47, December.
  2. Gordon, Myron J & Halpern, Paul J, 1976. "Bond Share Yield Spreads under Uncertain Inflation," American Economic Review, American Economic Association, vol. 66(4), pages 559-65, September.
  3. Martin Feldstei & Jerry Green & Eytan Sheshinski, 1978. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," NBER Chapters, in: Research in Taxation, pages 53-70 National Bureau of Economic Research, Inc.
  4. Cook, Timothy Q & Hendershott, Patric H, 1978. "The Impact of Taxes, Risk and Relative Security Supplies on Interest Rate Differentials," Journal of Finance, American Finance Association, vol. 33(4), pages 1173-86, September.
  5. Feldstein, Martin S, 1976. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," American Economic Review, American Economic Association, vol. 66(5), pages 809-20, December.
  6. Martin Feldstein & Lawrence Summers, 1977. "Is the Rate of Profit Falling?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(1), pages 211-228.
  7. James Tobin & William C. Brainard, 1976. "Asset Markets and the Cost of Capital," Cowles Foundation Discussion Papers 427, Cowles Foundation for Research in Economics, Yale University.
  8. Robert W. Crandall, 1978. "Federal Government Initiatives to Reduce the Price Level," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(2), pages 401-452.
  9. Patric H. Hendershott & Sheng Cheng Hu, 1979. "Inflation and the Benefits from Owner-Occupied Housing," NBER Working Papers 0383, National Bureau of Economic Research, Inc.
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Cited by:
  1. Feldstein, Martin, 1980. "Inflation, tax rules and the stock market," Journal of Monetary Economics, Elsevier, vol. 6(3), pages 309-331, July.
  2. Feldstein, Martin, 1980. "Tax Rules and the Mismanagment of Monetary Policy," American Economic Review, American Economic Association, vol. 70(2), pages 182-86, May.


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