Fiscal Implications of Price Level Changes and Investment Decisions
This paper explores the effect of inflation on the real value of shareholders’ equity given the current depreciation policy with respect to the corporate income taxes. Would partly debt financing of the firm’s activities make any difference? The analysis brings out the relevant economic issues on which tax depreciation policy during inflation should be based that is, its impact on the net cash flows to the firm. The objective is to compare the situation of the firm and stockholder with inflation to their situation without inflation. Our conclusions are that to protect the stockholders from the vagaries of inflation, we need to have tax laws such that each firm adjust its depreciation charges according to its particular debt structure. The proposal to increase depreciation in proportion to the inflation would lead to a gain for stockholders, except in the case of a completely equity financed firm.
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