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The Indexation of Interest, Depreciation, and Capital Gains: A Model ofInvestment Incentives

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  • Don Fullerton

Abstract

Despite much recent interest in a consumption tax, the Treasury Department's November 1984 tax plan proposes to adopt carefully coordinated features of a more comprehensive income tax, including the indexation of interest, depreciation, and capital gains.The May 1985 White House proposal would retain some of these indexing provisions.This paper looks at the incentives under alternative tax regimes to make marginal investments in the corporate sector, noncorporate sector, and in owner-occupied housing. It finds that the current system is characterized by effective tax rates that increase with inflation for some assets and decrease with inflation for other assets. Overall rates fall with inflation, and the corporate tax is completely offset by credits, allowances, and deductions. Under the Treasury or White House plans, the corporate tax re-emerges, effective tax rates are considerably more uniform, and the interference of inflation is virtually eliminated.

Suggested Citation

  • Don Fullerton, 1985. "The Indexation of Interest, Depreciation, and Capital Gains: A Model ofInvestment Incentives," NBER Working Papers 1655, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1655
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    1. Auerbach, Alan J & Kotlikoff, Laurence J & Skinner, Jonathan, 1983. "The Efficiency Gains from Dynamic Tax Reform," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(1), pages 81-100, February.
    2. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
    3. Bradford, David F., 1981. "The incidence and allocation effects of a tax on corporate distributions," Journal of Public Economics, Elsevier, vol. 15(1), pages 1-22, February.
    4. Mervyn A. King & Don Fullerton, 1983. "The Taxation of Income from Capital: A Comparative Study of the U.S., U.K., Sweden, and West Germany--The Theoretical Framework--," NBER Working Papers 1058, National Bureau of Economic Research, Inc.
    5. Don Fullerton, 1983. "Which Effective Tax Rate?," NBER Working Papers 1123, National Bureau of Economic Research, Inc.
    6. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416-416.
    7. Martin Feldstein & Lawrence Summers, 1983. "Inflation and the Taxation of Capital Income in the Corporate Sector," NBER Chapters,in: Inflation, Tax Rules, and Capital Formation, pages 116-152 National Bureau of Economic Research, Inc.
    8. 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.
    9. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    10. Alan J. Auerbach, 1979. "Wealth Maximization and the Cost of Capital," The Quarterly Journal of Economics, Oxford University Press, vol. 93(3), pages 433-446.
    11. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February.
    12. Charles L. Ballard & Don Fullerton & John B. Shoven & John Whalley, 1985. "Replacing the Personal Income Tax with a Progressive Consumption Tax," NBER Chapters,in: A General Equilibrium Model for Tax Policy Evaluation, pages 171-187 National Bureau of Economic Research, Inc.
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    Cited by:

    1. Alan J. Auerbach & James M. Poterba, 1987. "Tax Loss Carryforwards and Corporate Tax Incentives," NBER Chapters,in: The Effects of Taxation on Capital Accumulation, pages 305-342 National Bureau of Economic Research, Inc.
    2. Fullerton, Don & Henderson, Yolanda Kodrzycki, 1989. "A Disaggregate Equilibrium Model of the Tax Distortions among Assets, Sectors, and Industries," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(2), pages 391-413, May.
    3. Patric H. Hendershott, 1987. "Tax Changes and Capital Allocation in the 1980s," NBER Chapters,in: The Effects of Taxation on Capital Accumulation, pages 259-294 National Bureau of Economic Research, Inc.
    4. Don Fullerton & Yolanda Henderson, 1987. "The Impact of Fundamental Tax Reform on the Allocation of Resources," NBER Chapters,in: Taxes and Capital Formation, pages 101-104 National Bureau of Economic Research, Inc.
    5. David F. Bradford & Charles Stuart, 1986. "Issues in the Measurement and Interpretation of Effective Tax Rates," NBER Working Papers 1975, National Bureau of Economic Research, Inc.
    6. Patric H. Hendershott, 1985. "Tax Reform, Interest Rates and Capital Allocation," NBER Working Papers 1708, National Bureau of Economic Research, Inc.
    7. Joel Slemrod, 1985. "The Impact of Tax Reform on Households," NBER Working Papers 1765, National Bureau of Economic Research, Inc.
    8. Joel B. Slemrod, 1985. "The effect of tax simplification on individuals," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 29, pages 64-102.

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