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Hidden Stimuli to Capital Formation: Debt and the Incomplete Adjustment of Financial Returns

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  • Robert S. Chirinko
  • Stephen R. King

Abstract

There is a common belief that the disappointing economic performance in the 1970s can be attributed in good part to the interaction of tax rules, inflation, and capital formation. In this paper, we reassess the relationships between inflation, the tax code, and investment incentives because previous results are based on a number of tenuous assumptions whose impact has not been fully appreciated. We also question the appropriateness of the conventional user cost formulation, and derive an alternative measure taking explicit account of the role of debt -- acquisition,retirement, and net-of-tax interest payments -- and the equity holders' ownership of the firm. Our numerical results show that previously reported disincentives for acquiring capital goods in generaland against longer-lived capital in particular are attenuated, and in a number of cases reversed, under various sets of assumptions. Differences in results stemming from the conventional and modified user costs are highlighted, and are illustrated by a comparison of the U.S. Treasury's tax reform proposals under the two formulations.

Suggested Citation

  • Robert S. Chirinko & Stephen R. King, 1985. "Hidden Stimuli to Capital Formation: Debt and the Incomplete Adjustment of Financial Returns," NBER Working Papers 1684, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1684
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    1. 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.
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    6. Robert A. Taggart, Jr., 1980. "Taxes and Corporate Capital Structure in an Incomplete Market," NBER Working Papers 0594, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Fumio Hayashi, 1983. "Real and Financial Decisions of a Firm with Bankruptcy and Default: An Integration," NBER Working Papers 1097, National Bureau of Economic Research, Inc.

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