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Inflation and the Choice of Asset Life

  • Alan J. Auerbach
  • Martin Feldstein

Given the current corporate tax structure in the U.S., inflation may have an important impact on the production decisions of firms, notably the choice of capital durability. This paper presents a model of competitive behavior in which firms may choose the durability of their capital goods. We find that in the presence of inflation, the taxation of corporate profits may influence both the choice of asset life and the market value of equity. In particular, the failure to index depreciation allowances depresses share values and biases the choice of asset life toward greater durability. Integrating this analysis with the traditional one-sector monetary growth model, we study the general equilibrium impact of inflation on such long run characteristics of the economy as output per capita and the real rate of return received by investors.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0253.

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Date of creation: Jul 1978
Date of revision:
Publication status: published as Auerbach, Alan J. "Inflation and the Choice of Asset Life." Journal of Political Economy, Vol.87, No. 3, (1979), pp. 621-638.
Handle: RePEc:nbr:nberwo:0253
Note: PE
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  1. 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.
  2. 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.
  3. Aaron, Henry J, 1976. "Inflation and the Income Tax," American Economic Review, American Economic Association, vol. 66(2), pages 193-99, May.
  4. King, Mervyn A., 1975. "Taxation, corporate financial policy, and the cost of capital : A comment," Journal of Public Economics, Elsevier, vol. 4(3), pages 271-279, August.
  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. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72, pages 604.
  7. 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.
  8. Swan, Peter L, 1970. "Durability of Consumption Goods," American Economic Review, American Economic Association, vol. 60(5), pages 884-94, December.
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