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Inflation, Tax Rules, and Investment: Some Econometric Evidence

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  • Economics

Abstract

Inflation, Tax Rules, and Investment: Some Econometric Evidence This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Inflation, Tax Rules, and Capital Formation Volume Author/Editor: Martin Feldstein Volume Publisher: University of Chicago Press Volume ISBN: 0-226-24085-1 Volume URL: http://www.nber.org/books/feld83-1 Publication Date: 1983 Chapter Title: Inflation, Tax Rules, and Investment: Some Econometric Evidence Chapter Author: Martin Feldstein Chapter URL: http://www.nber.org/chapters/c11339 Chapter pages in book: (p. 243 - 286) 14 Inflation, Tax Rules, and Investment: Some Econometric Evidence My subject here is one to which Irving Fisher devoted considerable analytic and econometric effort: the effect of inflation on financial mar- kets and capital formation.1 Nowadays, every student learns of Fisher's conclusion that each percentage point increase in the steady-state infla- tion rate eventually raises the nominal interest rate by 1 percent, leaving the real rate of interest unchanged. Moreover, since the supply of saving depends on the real rate of interest and the demand for investable funds also depends on the real rate of interest, a change in the rate of inflation would have essentially no effect on the economy's real equilibrium. I say "essentially" no effect because another great Yale economist, James Tobin, reminded us in his 1964 Fisher Lecture that an increase in the nominal interest rate could cause households to substitute capital for money in their portfolios, thereby reducing the real interest rate. The Fisher-Tobin analysis, like most theoretical analyses of macroeco- nomic equilibrium, ignores the role of the taxes levied on capital income. While this may have been a reasonable simplification at some time in the past, it is quite inappropriate today. Taxes on capital income with mar- ginal rates that are often between one-third and two-thirds can have Reprinted by permissio

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