Working Paper Series
Villy Bergström and Jan Södersten
Inflation, Taxation and Capital Cost
Abstract: In times of inflation, most existing systems of taxation
introduce new distortions into the allocation of resources. In this paper,
the effects of inflation via taxes on the firm's east of capital are
analyzed. The taxes considered are the corporate income tax and household
taxes on dividends and capital gains. The first part of the paper presents
the model of a firm aiming at maximizing the value of its shares in the
portfolios of the stockholders. The nominal east of capital of this firm,
financed by equity and debt in a given proportion, is derived. The east of
equity and debt are then taken at their nominal values as the firm observes
them on the capital market.
We then analyze the net real cost of
capital, where market rates of return are adjusted for inflation. This
makes it possible to determine the net effects of inflation on capital
cost, recognizing several counteracting tendencies operating through the
tax system. It turns out that for most reasonable assumptions, the real
cost of capital will fall as a result of inflation when both profit tax and
taxes on dividends and capital gains are taken into account.
last section finally, we present different ways of indexing the system of
taxation to insulate it from inflationary distortions.
Keywords: Inflation; Taxation; Stock; (follow links to similar papers)
JEL-Codes: E31; H21; O16; (follow links to similar papers)
28 pages, January 1979
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