Inflation, Taxes, and the Durability of Capital

Posted: 23 Jul 1998

See all articles by Darrel S. Cohen

Darrel S. Cohen

Federal Reserve Board - Division of Research and Statistics

Kevin A. Hassett

American Enterprise Institute (AEI)

Date Written: October 29, 1997

Abstract

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.

JEL Classification: D92, E22, H32

Suggested Citation

Cohen, Darrel S. and Hassett, Kevin A., Inflation, Taxes, and the Durability of Capital (October 29, 1997). Available at SSRN: https://ssrn.com/abstract=110120

Darrel S. Cohen (Contact Author)

Federal Reserve Board - Division of Research and Statistics

Washington, DC 20551
United States
202-452-2376 (Phone)
202-452-3819 (Fax)

Kevin A. Hassett

American Enterprise Institute (AEI) ( email )

1150 17th Street, N.W.
Washington, DC 20036
United States
202.862.7157 (Phone)
202.862.7177 (Fax)

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