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Inflation, Capital Taxation, and Monetary Policy

In: Inflation: Causes and Effects

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  • Martin Feldstein

Abstract

This paper discusses the effects of the interaction between inflation and the taxation of capital income. The principal conclusions are: (1) Inflation substantially increases the total effective tax rate on the income from capital used in the nonfinancial corporate sector. The total effective tax rate has risen from less than 60 percent in the mid-1960's to more than 70 percent in the late 1970's. (2) The higher effective tax rate reduces the real net rate of return to those who provide investment capital. In the late 19701s, the real net rate of return averaged less than three percent. (3) The interact ion between inflation and existing tax rules contributed to the fall in the ratio of share prices to real pretax earnings, or, equivalently, to the rise in the real cost to the firm of equity capital. (4) By reducing the real net return to investors and by widening the gap between the firms' cost of funds and the maximum return that they can afford to pay, the interaction between tax rates and inflation has depressed the rate of net investment in business fixed capital. (5) The failure to consider correctly the effects of the fiscal structure has caused observers to underestimate the expansionary character of monetary policy in the past two decades. (6) The goal of increasing investment while maintaining price stability can be achieved with tight money, a high real interest rate, and tax incentives for investment. A high real net-of-tax interest rate could reduce residential investment and other forms of consumer spending while the tax incentives offset the monetary effect for investment in business capital.
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Suggested Citation

  • Martin Feldstein, 1982. "Inflation, Capital Taxation, and Monetary Policy," NBER Chapters,in: Inflation: Causes and Effects, pages 153-168 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:11457
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    References listed on IDEAS

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    1. Feldstein, Martin S, 1976. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," American Economic Review, American Economic Association, pages 809-820.
    2. Martin Feldstein & Joel Slemrod, 1983. "Inflation and the Excess Taxation of Capital Gains on Corporate Stock," NBER Chapters,in: Inflation, Tax Rules, and Capital Formation, pages 101-115 National Bureau of Economic Research, Inc.
    3. 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.
    4. 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.
    5. James M. Poterba, 1980. "Inflation, Income Taxes, and Owner-Occupied Housing," NBER Working Papers 0553, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Altig, David & Carlstrom, Charles T, 1991. "Inflation, Personal Taxes, and Real Output: A Dynamic Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 547-571, August.
    2. J. Bradford De Long, "undated". "America's Peacetime Inflation: The 1970s," J. Bradford De Long's Working Papers _104, University of California at Berkeley, Economics Department.
    3. Tobias Basse & Sebastian Reddemann, 2011. "Inflation and the dividend policy of US firms," Managerial Finance, Emerald Group Publishing, vol. 37(1), pages 34-46, January.
    4. Edge, Rochelle M. & Rudd, Jeremy B., 2007. "Taxation and the Taylor principle," Journal of Monetary Economics, Elsevier, pages 2554-2567.
    5. Rochelle M. Edge & Jeremy B. Rudd, 2002. "Taxation and the Taylor principle," Finance and Economics Discussion Series 2002-51, Board of Governors of the Federal Reserve System (U.S.).
    6. George S. Tavlas, 2009. "The Benefits And Costs Of Monetary Union In Southern Africa: A Critical Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, pages 1-43.
    7. Heer, Burkhard & Sussmuth, Bernd, 2007. "Effects of inflation on wealth distribution: Do stock market participation fees and capital income taxation matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 277-303, January.
    8. Amano, Robert A., 1998. "On the Optimal Seigniorage Hypothesis," Journal of Macroeconomics, Elsevier, pages 295-308.
    9. J. Bradford De Long, 1996. "America's Only Peacetime Inflation: The 1970s," NBER Historical Working Papers 0084, National Bureau of Economic Research, Inc.

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