PERSONAL TAXES, INFLATION AND MARKET VALUATION

In an inflation‐non‐indexed progressive tax system, inflation results in a “bracket‐creep” effect that reduces the demand for corporate debt while the tax‐deductibility of nominal interest makes the use of debt financing cheaper. The interactive effect of inflation and differential dividend and capi...

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Bibliographic Details
Published in:The Journal of financial research 1987, Vol.10 (4), p.341-352
Main Authors: Rashid, Muhammad, Amoako‐Adu, Ben
Format: Article
Language:English
Subjects:
Bond markets
Bonds
Capital gains
Corporate debt
Debt financing
Demand
Dividends
Inflation
Leverage
Market value
Mathematical models
Progressive taxes
Stockholders
Taxes
Valuation
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Summary:In an inflation‐non‐indexed progressive tax system, inflation results in a “bracket‐creep” effect that reduces the demand for corporate debt while the tax‐deductibility of nominal interest makes the use of debt financing cheaper. The interactive effect of inflation and differential dividend and capital gains taxes on the value of a levered firm is analyzed in this paper. Under a non‐indexed progressive tax system, inflation decreases the value of the unlevered firm but the effect of inflation on the firm's debt‐to‐asset ratio is theoretically indeterminate. The gain from leverage is also derived and compared with other valuation models.
ISSN:0270-2592
1475-6803
DOI:10.1111/j.1475-6803.1987.tb00507.x