Capital Formation in an Inflationary Environment: An Empirical Assessment

• Published in: Southern economic journal 1982-01, Vol.48 (3), p.651-661
• Main Authors: Maloney, Michael T., Prinzinger, Joseph, Ulbrich, Holley
• Format: Article
• Language: English
• Subjects: Capital formation; Capital gains; Capital investments; Consumer Price Index; Corporate income tax; Corporate taxes; Economic theory; Equity; GNP; Gross National Product; Growth models; Income taxes; Inflation; Inflation rates; Inflation tax; Investment return rates; Personal income taxes; Rates of return; Taxation
• ISSN: 0038-4038; 2325-8012
• DOI: 10.2307/1058657

An empirical test is presented of the proposition that inflation working through the tax system is a deterrent to investment. The joint effect of taxes and inflation on investment has been investigated theoretically by Feldstein in previous research but not tested empirically. Feldstein (1976) brings taxes and inflation together into a neoclassical growth model and concludes that increased inflation will reduce capital intensity without tax indexing and for a credible variety of parameters. In the work presented, the effect of inflation, which works through the given tax construct to affect the rate of capital formation, is empirically identified through the use of a generalized distributed-lag model. The empirical evidence strongly supports the contention that the net effect of inflation on capital formation has been negative over the time period 1953-1978. While the key variable traditionally linked with capital formation, real gross national product (GNP), would have entailed a substantial increase in real capital formation during the time period being considered, it is partially offset by the effect of accelerating inflation. This stimulates real policy questions for countries following an inflation-biased growth or development policy.