The role of the nominal tax system in the common stock returns/expected inflation relationship

Abstract

Recent empirical evidence suggests that common stock returns and expected inflation are negatively related. This paper focuses on one explanation of this relationship, a nominal tax approach. According to this theory, in countries with specific nominal tax components to their tax systems, inflation increases the effective tax rate, thereby lowering after-tax returns. Analyzing monthly data for Germany, Japan, the Netherlands, Sweden, and the U.S. for the period 1960–1981, and annual data for the U.K. and U.S. for the period 1870–1980, I find little empirical support for the nominal tax approach.