Taxes, Inflation, and the Durability of Capital

Abstract

The choice of capital durability is affected by the rate of inflation because nominal depreciation deductions are based on historical cost rather than replacement cost. This paper analyzes a model with competitive firms and demonstrates that an increase in the rate of inflation will lead to an increase in the durability of capital, if the ratio of the nominal discount rate to the rate of depreciation exceeds a critical value. However, if this ratio is less than the crucial value, this effect is reversed. The effect of costs of adjustments on the crucial value is analyzed.

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