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Inflation, taxes, and the durability of capital

  • Darrel Cohen
  • Kevin A. Hassett

Auerbach (1979, 1981) has demonstrated that inflation can lead to large inter-asset distortions, with the negative effects of higher inflation unambiguously declining with asset life. We show that this is true only if depreciation is treated as geometric for tax purposes. When depreciation is straightline, higher inflation can have the opposite effect, discouraging investment in long-lived assets. Since our current system can be thought of as a mixture of straightline and geometric, the sign of the inter-asset distortion is indeterminate. We show that under current U.S. tax rules, the "straightline" and "geometric" effects approximately cancel for equipment, causing almost no inter-asset distortions. For structures, inflation clearly causes substitution into long-lived assets.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1997-53.

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Date of creation: 1997
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Handle: RePEc:fip:fedgfe:1997-53
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  1. Alan J. Auerbach & Martin Feldstein, 1978. "Inflation and the Choice of Asset Life," NBER Working Papers 0253, National Bureau of Economic Research, Inc.
  2. Alan J. Auerbach, 1982. "Taxation, Corporate Financial Policy and the Cost of Capital," NBER Working Papers 1026, National Bureau of Economic Research, Inc.
  3. Darrel Cohen & Kevin A. Hassett & R. Glenn Hubbard, 1997. "Inflation and the User Cost of Capital: Does Inflation Still Matter?," NBER Working Papers 6046, National Bureau of Economic Research, Inc.
  4. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc.
  5. Alan J. Auerbach, 1980. "Share Valuation and Corporate Equity Policy," NBER Working Papers 0255, National Bureau of Economic Research, Inc.
  6. Alan J. Auerbach, 1980. "Inflation and the Tax Treatment of Firm Behavior," NBER Working Papers 0547, National Bureau of Economic Research, Inc.
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