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The tax effect, and the recent behaviours of the after-tax real rate : is it too high?

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  • Yash P. Mehra
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    Concerns that interest rates are too high have been prevalent throughout the 1980s. Even after adjusting for expected inflation, many people argue that real interest rates are inordinately high by historical standards. Yash Mehra, in his article “The Tax Effect and the Recent Behaviour of the After-Tax Real Rate: Is It Too High?”, points out that because interest income is taxed, business decisions are based on the after-tax real rate and public concern should focus on this measure of interest rates. Mehra adds to the accumulating evidence that changes in taxes on interest income alter the nominal interest rate. He suggests that unusual interest rates occurred in the 1970s, when the after-tax real rate was negative because of rising inflation and shocks to the supply side of the economy, such as oil price increases. Today’s real interest rate may appear high relative to the negative levels observed in the ‘70s; however, after-tax real short-term rates in the 1980s have not been significantly higher than they were in the ‘50s and ‘60s.

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    Article provided by Federal Reserve Bank of Richmond in its journal Economic Review.

    Volume (Year): (1984)
    Issue (Month): Jul ()
    Pages: 8-20

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    Handle: RePEc:fip:fedrer:y:1984:i:jul:p:8-20:n:v.70no.4
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    1. Silver, J Lew & Fackler, James S, 1982. "Inflationary Expectations, Economic Activity, Taxes, and Interest Rates: Comment," American Economic Review, American Economic Association, vol. 72(4), pages 858-859, September.
    2. Makin, John H, 1978. "Anticipated Inflation and Interest Rates in an Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 275-289, August.
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    8. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters,in: Inflation, Tax Rules, and Capital Formation, pages 28-43 National Bureau of Economic Research, Inc.
    9. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-793, May.
    10. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-276, June.
    11. Davidson, Russell & MacKinnon, James G., 1983. "Testing the specification of multivariate models in the presence of alternative hypotheses," Journal of Econometrics, Elsevier, vol. 23(3), pages 301-313, December.
    12. Ayanian, Robert, 1983. "Expectations, Taxes, and Interest: The Search for the Darby Effect," American Economic Review, American Economic Association, vol. 73(4), pages 762-765, September.
    13. Lahiri, Kajal, 1976. "Inflationary Expectations: Their Formation and Interest Rate Effects," American Economic Review, American Economic Association, vol. 66(1), pages 124-131, March.
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    15. Melvin, Michael, 1982. "Expected Inflation, Taxation, and Interest Rates: The Delusion of Fiscal Illusion," American Economic Review, American Economic Association, vol. 72(4), pages 841-845, September.
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