Inflation Expectations, Business Taxation And The Incentive To Invest In Depreciable Capital Goods

Abstract

A parochial issue in business taxation - one which was discussed vigorously during the U.S. 2007-2009 economic contraction is the issue of how corporate Federal income tax policy affects incentives for businesses to undertake new investments in capital goods. This paper focuses on the question of how the tax treatment of depreciation affects the incentives of business to invest in capital goods when businesses (rightly or wrongly) expect significant inflation during the depreciable life of the investment. An innovative idea of adjusting the system of tax depreciation for inflation is to allow an immediate deduction for the present value of the future economic depreciation that firms could claim if there were zero inflation. No adjustment for inflation would ever be needed because the depreciation charge would be taken in the same year in which the asset was purchased. The result of this approach is consistent with the result for inflation-adjusted historical cost depreciation because gains from changes in the relative prices of depreciable assets would be included in income.